Recoupment, Market Power, And Predatory Pricing

Recoupment inquiries play an important role in predatory pricing cases. Nevertheless, their place in antitrust analysis is unclear and potentially problematic in ways that are not fully appreciated. Does a recoupment requirement define, augment, or replace the preexisting monopoly power requirement that involves similar analysis? How can a recoupment test be inserted in sequential assessments of alleged predatory pricing when all of the steps are intertwined with the others, including those deemed to come later? Why is a plaintiff permitted to show either that recoupment was ex ante plausible or that sufficient ex post profit recovery occurred, rather than requiring one in particular, or both? This article addresses these questions by examining the underlying purposes of recoupment assessments and predatory pricing inquiries more broadly. As will become evident, much of the analysis is relevant not just to predatory pricing but to other forms of anticompetitive conduct as well.

The concept of recoupment is simple: if firms are presumed to undertake predation to enhance their profits, then a firm that indeed engaged in predation must have expected that the short-run profit sacrifice (from dropping its price to drive out or discipline rivals) would generate a sufficient long-run profit recovery (when it later became able to charge high prices) to render the overall strategy profitable. Restated as the contrapositive: if the firm would have expected its long-run profit enhancement to be insufficient, then it must not have engaged in predation. This latter inference has become part of U.S. antitrust law on predatory pricing and is most associated with the Supreme Court’s decisions in Brooke Group and Matsushita.

It is not surprising that economic analysis of exclusionary strategies has long examined their profitability through what is akin to a recoupment condition and understood recoupment to be central to predatory pricing analysis in particular. And even without drawing explicitly on the economics literature, long before any Supreme Court cases explicitly embraced recoupment it was always open to parties to present evidence relating to whether an alleged action could be expected to be profitable and hence plausible. One need not master rocket science or game theory to argue: “Don’t believe their allegation that we were trying to do X. That strategy would have lost us millions. We’re not stupid!” It is not immediately obvious what announcement of the necessity for recoupment adds, except to remind parties that common sense arguments are welcome.

Yet the relationship between predation and recoupment raises many questions, some of which are occasionally noticed but have not been resolved and others that have remained hidden. Even the simple recoupment logic is not so simple. Granting the contrapositive—that the lack of a plausible expectation of recoupment negates an explanation that presupposes recoupment—the original proposition remains: an affirmative demonstration of predation itself implies a reasonable expectation of recoupment. And those alleging predatory pricing have always had to prove their case. So why isn’t any recoupment requirement automatically satisfied if a case is otherwise sufficient?

A further puzzle involves the relationship between the presence of significant market power and the need for a recoupment inquiry. After all, antitrust challenges under Sherman Act Section 2, where many predatory pricing cases fall, require proof of monopoly power or a dangerous probability thereof. In addition, inquiries into monopoly power and recoupment examine similar factors in similar ways. Furthermore, antitrust scrutiny in particular cases is conventionally understood to begin with the monopoly power requirement, so one might have thought that, if and when the predatory pricing inquiry was reached, significant recoupment would in essence have already been established. How do the monopoly power and recoupment requirements relate to each other? Does the latter repeat, refine, augment, or replace the former? If it supplants, did Brooke Group implicitly reverse decades of precedent, including the Spectrum Sports case that the Court decided just months before and cited in support of its decision?

These questions and others raised below suggest that recoupment—in particular, how it fits with the broader inference process and relates to other aspects of predatory pricing analysis—is underexplored. This article examines such questions from the perspective of how liability assessments should be made in order best to deter anticompetitive behavior while minimizing the chilling of procompetitive behavior. As will be seen, we can only make sense of recoupment by integrating it with the rest of the inquiry rather than examining it in isolation, as has often been done. (As a note to the reader before proceeding, throughout this article “recoupment” is used to refer only to the adequacy of expected profit recovery conditional on a defendant’s strategy otherwise being successful.)

Part I examines market power and recoupment in light of the aforementioned monopoly power requirement and the apparent overlap in the two sorts of analysis. It begins by carefully examining the development of the recoupment requirement in the Supreme Court, with particular attention to its relationship to Sherman Act Section 2’s longstanding monopoly power requirement. Then it examines the analytical relationship between the two concepts. Direct attention to the components of the recoupment condition reveals some concordance but also critical differences. Indeed, a conventional application of the monopoly power requirement can lead to rejection of challenges for reasons that actually favor liability because they imply greater anticompetitive effects that generate more long-run profit recovery. Furthermore, despite similarities in factors and analysis, market power is not a very helpful concept for recoupment analysis. Market power’s relevance in other ways is also considered.

Part II addresses sequential assessments that have achieved some traction with courts and commentators. It is often suggested that the proper order of inquiry is, first, market power; then, anticompetitive effects; and, finally, procompetitive explanations. For predatory pricing cases, Brooke Group is taken to split the middle inquiry into two steps: an inquiry into predation itself (in the form of some price-cost test), followed by an examination of recoupment—although some would reverse this order. This sort of sequential assessment, however, is contrary to a logical inference process that by its nature involves triangulation: a consideration of how various evidence on interrelated factors collectively bears on a single ultimate question. Such preordained sequencing also conflicts with practical considerations in the gathering and processing of evidence.

As Part II explains, these problems arise with respect to each of the supposedly separate components of predatory pricing analysis. Market power cannot properly be defined or assessed up front, in a vacuum, among other reasons because of its relationship to recoupment. Recoupment, as alluded to previously, is intimately related to the direct predation inquiry, in addition to overlapping with market power. Procompetitive explanations, in turn, need to be explicitly linked with the analysis of market power, predation, and recoupment. The common practice—in commentary, agency guidance, and court opinions—of conducting separate, sequenced inquiries may partly explain important shortcomings in prior efforts, including the failure even to notice some of the key challenges.

Part III turns to the distinction between ex ante and ex post recoupment. Cases and commentary are aware of the difference between inquiry into whether alleged predation should have been regarded as profitable at the time the strategy was undertaken and whether it turned out to be so after the fact. However, insufficient attention has been given to how cases should be resolved when these two recoupment inquiries seem to yield conflicting answers. In particular, ex ante profitability followed by ex post failure raises the question of whether it is optimal in this context to punish failed attempts. The lack of explicit attention to this matter is surprising given its importance and Sherman Act Section 2’s explicit coverage of attempted monopolization.

Part IV turns briefly to questions about the operation of legal institutions. It is widely understood that many antitrust cases, including those involving allegations of predatory pricing, are quite challenging. The complexity of the analysis combined with significant uncertainty about the facts, along with serious concerns about false positives that may chill procompetitive activity, led first to the rise of cost-based tests and then (perhaps in part because these too proved difficult) to the addition of an explicit recoupment inquiry. This article’s analysis indicates, unfortunately, that the problem is even more daunting than generally recognized. This Part offers some comments on how agencies and courts might rise to the challenge, with emphasis on the potential role of recoupment and other inquiries in screening out weak cases.

Much of the present analysis is not distinctive to recoupment or even to predatory pricing more broadly. This investigation aims to identify fruitful directions for research, inform policy-making, and guide the investigation and resolution of particular disputes regarding a wide range of potentially anticompetitive practices. Some lessons are collected in the conclusion.

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