Excessive Prices and Profitability

What is a Fair Profit?

Economic & Financial Consulting | Competition Law Insight (Reprint)

August 28, 2015

Competition authorities are typically concerned that a lack of competition in a market may harm consumers. One way that economics predicts that firms could abuse a dominant market position is through charging “excessive” prices. Authorities usually investigate this by analysing firms’ profitability. Although politicians, consumer groups and others may often claim that certain firms are earning “too much” profit, it can in fact be very difficult to calculate the true “economic profitability” of a firm. This is because accounting measures of profitability do not capture all of the relevant economic costs faced by a business.

In our experience, there are various approaches to assessing economic profitability and it is essential to weigh up the available evidence and take great care in interpreting it. In this article, we explore some of the theoretical and practical hurdles that must be overcome in order to produce quantitative analysis of profitability that is sufficiently robust to reach a conclusion on whether or not prices are excessive.

The definition of a dominant firm was first established in the Hoffmann-La Roche case as one that has “the power to behave to an appreciable extent independently of its competitors, its customers and ultimately of the consumers”. Economic theory says that, if a firm has market power, one way it can abuse this dominance is to raise prices above the level that would prevail in a competitive market in order to earn “supernormal” profits.

Although the European Commission has made a number of high-profile findings of abuse of dominance by firms under article 102 in recent years, such as the €561m fine imposed on Microsoft in 2013, none of the major cases has related to excessive pricing. The article cites the imposition of “unfair” prices as an example of potentially abusive conduct. However, given that none of the major cases has related to excessive pricing, does this mean that dominant firms are not charging prices higher than those that would arise in a competitive market?

Posted with permission from Informa UK. Copyright ©2015. All rights reserved.

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