The Cost-Based Standard
In Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., the Supreme Court established a two-part test for plaintiffs: whether bringing a predatory pricing claim under the Sherman Act or asserting primary-line price discrimination under the Robinson-Patman Act, a plaintiff must show that (1) the prices complained of are below “an appropriate measure of its rival’s costs” and (2) the rival has “a reasonable prospect, or . . . a dangerous probability, of recouping its investment in below-cost prices.” 509 U.S. 209, 222, 224 (1993).
The Court suggested that an antitrust injury generally does not arise from above-cost prices. However, it consciously declined to define what the “appropriate measure of cost” should be. Instead, the Court accepted the parties’ proposed measure—average variable cost (AVC)—without resolving the issue, leaving ambiguities and unresolved questions for lower courts.
Nonetheless, a review of federal courts’ opinions analyzing appropriate measures of cost in the wake of Brooke Group yields important insights for expert testimony.
Some courts tend to favor short-run marginal cost tests.
Supreme Court precedent states that predatory prices are those “above some measure of incremental cost.” Id. at 223 (quoting Cargill, Inc. v. Monfort of Colo., Inc., 479 U.S. 104, 117 n.12 (1986)). Generally, economists interpret that guidance to mean that the identification of predatory prices requires “essentially a marginal-cost test.” P. Areeda & H. Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application ¶ 739a (5th ed. 2021). Where a price-cost comparison based on a firm’s long-run costs may not yield an accurate result, courts favoring administrability and practicality have focused on a measure of short-run marginal costs to determine the average additional incremental cost of supplying and selling the next single unit. See Barry Wright Corp. v. ITT Grinnell Corp., 724 F.2d 227, 234–36 (1st Cir. 1983) (Breyer, J.); MCI Commc’ns Corp. v. Am. Tel. & Tel. Co., 708 F.2d 1081 (7th Cir. 1983); Areeda & Hovenkamp, supra, ¶ 739a.
Distinguish between fixed and variable costs, and be prepared to describe the economic intuitions behind the price-cost analysis.
Marginal cost can be difficult to measure; so, as Brooke Group illustrated, proxy measures serve as useful tools in the analysis. Many courts have adopted AVC as their preferred cost-based measure in predatory pricing cases. See e.g., United States v. AMR Corp., 335 F.3d 1109, 1116 (10th Cir. 2003) (citing Second, Third, Fifth, Sixth, and Ninth Circuit cases as support). Some courts consider additional proxy measures, such as average avoidable cost (consisting of costs that could be avoided if the firm were to reduce its outputs). However, it has been challenging on the facts of certain cases for some courts to accept a measure that relies on fixed costs—e.g., a test based on a firm’s average total cost (consisting of both fixed and variable costs). See, e.g., Duke Energy Carolinas, LLC v. NTE Caroinas II, LLC, 2022 WL 2293908 (W.D.N.C. June 24, 2022); Superior Prod. P’ship v. Gordon Auto Body Parts Co., 784 F.3d 311 (6th Cir. 2015); Rebel Oil Co. v. Atl. Richfield Co. (Rebel II), 957 F. Supp. 1184 (D. Nev. 1997); MCI, 708 F.2d at 1116–17.
Importantly, courts have treated “the choice of a cost-based standard for evaluating claims of predatory pricing [a]s a question of law to be decided by the trial judge.” MCI, 708 F.2d at 1111. Given the generalist nature of courts, judges have relied on economists’ explanations of cost inputs. See id. at 1114–15; Duke, 2022 WL 2293908, at **14, 16. Accordingly, persuasive testimony from an economist about the relevant costs to consider in a price-cost test is important.
A Circuit Review
Courts differ in their flexibility in applying cost measures. For that reason, knowledge of a particular court’s approach is important for achieving a court’s acceptance and crediting of expert testimony.
For example, the U.S. Court of Appeals for the Second Circuit has expressly adopted AVC as its cost‑based measure by “bar[ring] claims of predatory or anti-competitive pricing unless the price charged was below short-run [AVC].” Info. Res., Inc. v. Dun & Bradstreet Corp., 359 F. Supp. 2d 307 (S.D.N.Y. 2004) (quoting Ne. Tel. Co. v. AT&T, 651 F.2d 76, 86–89 (2d Cir. 1981)).
In contrast, the U.S. Court of Appeals for the Tenth Circuit has acknowledged that “there may be times when courts need the flexibility to examine both AVC as well as other proxies,” depending on the circumstances of the case. AMR, 335 F.3d at 1116. In United States v. AMR Corp., the court examined four cost measures proffered by the government’s experts in support of exclusionary conduct allegations asserting that a dominant airline carrier added capacity on certain flight routes that cost more than the revenue they generated. The court concluded that each test was “fundamentally reliable.” 335 F.3d at 1116. Rather than creating tests to measure the precise costs associated with the capacity additions, the government’s experts relied on the company’s internal accounting descriptions, which included fixed costs and various operating costs that were not associated with adding capacity.
Some courts have rejected cost-based inputs that rely on market prices or opportunity costs.
The U.S. Court of Appeals for the Sixth Circuit also declined to favor AVC to the exclusion of other marginal-cost proxies in Superior Production Partnership v. Gordon Auto Body Parts Co. As the court explained, “the appropriate measure of cost has some flexibility”—but does not serve as a blank check. 784 F.3d 311, 325 (6th Cir. 2015). The court rejected the expert witness’s opinion that forgone profits demonstrated exclusionary conduct and admitted an expert’s opinion that the challenged prices were not predatory because they “never fell below average avoidable cost” and recoupment of any such losses would be improbable. Id. at 323.
One district court in the U.S. Court of Appeals for the Ninth Circuit also declined to consider opportunity costs, as well as market prices, in an expert analysis of the price-cost comparison in Rebel II. 957 F. Supp. 1184 (D. Nev. 1997). The court rejected the expert witness’s opinion based solely on an agreement that, by its own terms, did not reflect the actual price paid by the defendant and merely measured a defendant’s opportunity cost in maximizing its profit. Moreover, the expert’s reliance on the agreement required a comparison based on market prices, a measure that Brooke Group discredited.
Some courts have favored expert reports that present data consistent with the real world.
Whatever the measure of cost, courts have favored a price-cost analysis based on actual (i.e., not hypothetical) prices and the contemporaneous structure of the market at issue.
For example, in Felder’s Collision Parts, Inc. v. All Star Advertising Agency, Inc., the U.S. Court of Appeals for the Fifth Circuit rejected an expert’s price-cost analysis that excluded post-sale rebate amounts from the calculation of the defendant’s AVC. 777 F.3d 756 (5th Cir. 2015). Without inclusion of the rebate, the defendant’s prices would have been below cost; with it, prices were above cost. The Fifth Circuit concluded that “comparing price and cost as they exist only on the day of the sale ignores the economic realities that govern antitrust analysis,” and the rebate must be included in the cost analysis. Id. at 763.
Similarly, in Concord Boat Corp. v. Brunswick Corp., the U.S. Court of Appeals for the Eighth Circuit reversed a jury verdict for the plaintiff after discrediting its expert testimony. 207 F.3d 1039 (8th Cir. 2000). Specifically, the court determined that the testimony was improperly speculative because it ignored the “realities of the marketplace” when it failed to account for a rival’s product recall or the effects of a merger by two market competitors. Id. at 1062.
Some courts favor testimony that accounts for the nontraditional role of “costs” when appropriate.
In the case of bundled products or discounts, the ordinary price-cost rules may not cleanly apply, and expert witnesses should account for the unique nature of the price-cost relationship in their opinion.
As one New York district court explained, “a firm that enjoys a monopoly on one or more of a group of complementary products, but which faces competition on others, can price all of its products above [AVC] and yet still drive an equally efficient competitor out of the market.” Ortho Diagnostic Sys., Inc. v. Abbott Labs., 920 F. Supp. 455, 467 (S.D.N.Y. 1996). Recognizing the distinction of facts at issue in Brooke Group, that court developed the following rule for pricing conduct involving the sale of multiple products packaged together:
[A] Section 2 plaintiff in a case . . . in which a monopolist (1) faces competition on only part of a complementary group of products, (2) offers the products both as a package and individually, and (3) effectively forces its competitors to absorb the differential between the bundled and unbundled price of the product in which the monopolist has market power [] must allege and prove either that (a) the monopolist has priced below its [AVC] or (b) the plaintiff is at least as efficient a producer of the competitive product as the defendant, but that the defendant’s pricing makes it unprofitable for the plaintiff to continue to produce.
Id. at 469.
In LePage’s Inc. v. 3M, the U.S. Court of Appeals for the Third Circuit also distinguished the traditional Brooke Group standard from its analysis of cases involving sales of a bundle of multiple products. LePage’s, 324 F.3d 141 (3d Cir. 2003). The LePage’s court sustained a jury verdict in favor of a single product retailer that alleged its competitor, 3M, had foreclosed rivals from the relevant market by implementing bundled rebates across multiple 3M product lines, which included the one competitive product at issue. The Third Circuit rejected 3M’s argument that its rebates were above cost, and thus lawful under Brooke Group, concluding that the Supreme Court’s decision concerning a single-product oligopoly was inapposite to a case concerning a multiproduct monopolist’s bundled discounts. The court concluded that 3M’s pricing strategy was predatory because it foreclosed a “potential competitor who does not manufacture an equally diverse group of products and who therefore cannot make a comparable offer.” Id. at 155.
Ninth Circuit courts have applied a “discount attribution” standard, under which a bundled discount is exclusionary if, after allocating the full amount of the discounts to the competitive product, the resulting price is below the firm’s incremental cost to produce it. See Cascade Health Sols. v. PeaceHealth, 515 F.3d 883 (9th Cir. 2008). However, courts in that circuit have not applied the same analysis to cases involving the manufacturing of patented pharmaceutical drugs, where variable costs are typically low and costs consist of high up-front research and development investments and commercialization expenses, which a district attribution standard would fail to capture adequately. See Meijer, Inc. v. Abbott Labs., 544 F. Supp. 2d 995 (N.D. Cal. 2008).
Conclusion
Despite unanswered questions that remain after Brooke Group, lower courts’ opinions following that decision have provided further context and guidance to assist the decision of admitting or excluding expert evidence in predatory pricing cases. A lesson that remains constant throughout the above decisions is that courts routinely credit evidence that is consistent with the actual economics and structure of the marketplace at issue. As the analysis of predatory pricing evidence will vary from case to case, the best path forward is for experts (with counsel) to take time at the outset to understand the cost-based standard applicable in the relevant jurisdiction and prepare to persuasively explain the intricacies of their chosen method.
