Pricing Legal Concerns

Unfair Trade Practices

Unfair business practices are oppressive or unconscionable acts by companies against consumers or other stakeholders.

Learning Objectives

Explain the concept of unfair trade practices relative to legal concerns and pricing

Key Takeaways

Key Points

  • Unfair business acts are generally prohibited by law, so committing them may force a company to provide for the award of compensatory damages, punitive damages, and payment of the plaintiff’s legal fees.
  • Two major forms of unfair trade practice are fraud and misrepresentation.
  • Unfair trade practices not only affect consumers, but may affect other stakeholders as well, such as competitors and investors.

Key Terms

  • fraud: Any act of deception carried out for the purpose of unfair, undeserved, or unlawful gain.
  • misrepresentation: A false statement of fact made by one party to another party, which has the effect of inducing that party into the contract.

Unfair Trade Practices

Unfair business practices include oppressive or unconscionable acts by companies against consumers and others. In most countries, such practices are prohibited under the law. Unfair trade practices can occur in many different areas such as insurance claims and settlement, debt collection, and tenancy issues.

Unfair trade practices also include such acts as:

  • Fraud: This is an intentional deception made for the company’s gain or to damage the other party.
  • Misrepresentation: This is a false statement of fact made by one party to another party, which has the effect of inducing that party into the contract. For example, under certain circumstances, false statements or promises made by a seller of goods regarding the quality or nature of the product may constitute misrepresentation.

In addition to providing for the award of compensatory damages, laws may also provide for the award of punitive damages as well as the payment of the plaintiff’s legal fees. When statutes prohibiting unfair and deceptive business practices provide for the award of punitive damages and attorneys fees to injured parties, they provide a powerful incentive for businesses to resolve the claim through the settlement process rather than risk a more costly judgment in court.

In the European Union, each member state must regulate unfair business practices in accordance with the Unfair Commercial Practices Directive, subject to transitional periods. This is a major reform of the law concerning unfair business practices in the European Union.

Unfair trade practices not only affect consumers, but other stakeholders as well. Unfair competition in a sense means that the competitors compete on unequal terms, because favorable or disadvantageous conditions are applied to some competitors but not to others; or that the actions of some competitors actively harm the position of others with respect to their ability to compete on equal and fair terms. Often, unfair competition means that the gains of some participants are conditional on the losses of others, when the gains are made in ways which are illegitimate or unjust.

Illegal Price Advertising

Deceptive price advertising uses misleading or false statements in advertising and promotion and is usually illegal.

Learning Objectives

Describe the concept and types of illegal price advertising

Key Takeaways

Key Points

  • While deceptive price advertising is usually illegal, in practice, it can be difficult to stop or difficult to enforce any law relating to it.
  • False and deceptive advertising methods include hidden fees and surcharges, “going out of business” sales, manipulation of measurement units, fillers, oversized packaging, bait and switch, etc.
  • Advertising need not be proven to be deceptive for it to be illegal. What matters is the potential to deceive, which happens when consumers see the advertising to be stating to them, explicitly or implicitly, a claim that they may not realize is false and material.

Key Terms

  • surcharge: An addition of extra charge on the agreed or stated price.
  • bait-and-switch: Relating to use of bait and switch (offering one attractive exchange initially, but not honoring the offer) in business, politics, and elsewhere.

Illegal Price Advertising

Deceptive or false advertising is the use of misleading or outright false statements by companies in their advertising and promotional material. Depending on the type and the severity, deceptive advertising is usually illegal, because it is recognized that advertising has the potential to persuade people to enter into commercial transactions that they may otherwise avoid. However, advertisers still find ways to deceive consumers in ways that are legal or technically illegal but unenforceable.

Types of Illegal Price Advertising

Hidden fees and surcharges

These are fees that are not stated in the advertised price. These are particularly common for services, such as cell phone activation, broadband, gym memberships, and air travel. Generally, companies get away with it, because the fees are hidden in fine print and obfuscated by technical language.

“Going out of business” sales

Often, companies that supposedly are liquidating will raise prices on items marked for clearance, meaning that the company increases the price and “discounts” it. Thus, the discount is less than advertised. Another case, at liquidating stores (if it is a retail chain), the sales prices at the chain’s other stores is lower than the liquidator’s prices at the closing stores. On top of this, sale items are often “final sale,” meaning returns are not accepted. Thus, there is no recourse for customers.

Manipulation of measurement units and standards

Sellers may manipulate standards to mean something different than their widely understood meaning. One example is the personal computer’s hard drive. By stating the sizes of hard drives in “megabytes” of 1,000,000 bytes, instead of 1,048,576, they overstate capacity by nearly 5%. With gigabytes, the error increases to over 7% (1,073,741,824, instead of 1,000,000,000) and nearly 10% for the newer terabyte. Seagate Technology and Western Digital were sued in a class-action suit for this deception. Both companies agreed to settle the suit and reimburse customers in kind, yet they still continue to advertise this way.

In another example, Fretter Appliance stores claimed “I’ll give you five pounds of coffee if I can’t beat your best deal. ” While initially they gave away that quantity, they later redefined them as “Fretter pounds,” which, unsurprisingly, were much lighter than standard pounds.

Fillers and oversized packaging

Some products are sold with fillers, which increase the legal weight of the product with something that costs the producer very little compared to what the consumer thinks that he or she is buying. Food is an example of this, where TV dinners are filled with gravy or other sauce instead of meat. Malt and cocoa butter have been used as filler in peanut butter.

Manipulation of terms

Many terms do have some meaning, but the specific extent is not legally defined, leading to their abuse. A frequent example (until the term gained a legal definition) was “organic” food. “Light” food also is an even more common manipulation: The term has been variously used to mean low in calories, sugars, carbohydrates, salt, texture, thickness (viscosity), or even light in color. Tobacco companies, for many years, used terms like “low tar,” “light,” “ultra-light,” “mild,” or “natural” in order to imply that products with such labels have less detrimental effects on health but in recent years, it was proven that those terms were considered misleading. Naturally, these manipulations of terms are used to charge a higher price, particularly on “‘organic” products.

Incomplete/inconsistent comparison

“Better” means one item is superior to another in some way, while “best” means it is superior to all others in some way. However, advertisers frequently fail to list in what way the items are being compared (price, size, quality, etc.) and, in the case of “better,” to what they are comparing. In an inconsistent comparison, an item is compared with many others, but only compared with each on the attributes where it wins, leaving the false impression that it is the best of all products, in all ways. This is common with price-comparing Internet websites.

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Listerine Advertisement, 1932: From 1921 until the mid-1970s, Listerine was also marketed as a preventive and remedy for colds and sore throats. In 1976, the Federal Trade Commission ruled that the claims were misleading.

Bait-and-switch

Advertisers advertise an item that is unavailable when the consumer arrives at the store and is then sold a similar product at higher price. Bait-and-switch is legal in the United States, provided that ads state that there is a limited supply and that no rain checks will be offered.

Legal regulations

Advertising is regulated by the authority of the Federal Trade Commission to prohibit “unfair and deceptive acts or practices in commerce. ” What is illegal is the potential to deceive, which is interpreted to occur when consumers see the advertising to be stating to them, explicitly or implicitly, a claim that they may not realize is false and material. The goal is prevention rather than punishment, reflecting the purpose of civil law in setting things right rather than that of criminal law.

Predatory Pricing

Predatory pricing is the practice of selling a product or service at a very low price, intending to drive competitors out of the market.

Learning Objectives

Examine the characteristics of predatory pricing relative to legal concerns

Key Takeaways

Key Points

  • After the weaker competitors are driven out, the surviving business can raise prices to supra competitive levels. The predator hopes to generate revenues and profits in the future that will more than offset the losses it incurred during the predatory pricing period.
  • While predatory pricing is illegal in many countries, it is very difficult to prove that a company has undertaken a strategy of predatory pricing rather than competitive pricing.
  • Critics argue that the prey know that the predator cannot sustain low prices forever, so it is essentially a game of chicken: if they can ride it out, they will survive.

Key Terms

  • predatory pricing: A strategy of selling goods or services at a very low price in order to drive one’s competitors out of business (at which point one can raise one’s prices more freely).
  • low-cost signalling: A strategy of signalling to competitors that you intend to pursue a low-cost strategy.

Predatory Pricing

Predatory pricing is the practice of selling a product or service at a very low price, with the intention of driving competitors out of the market, or create barriers to entry for potential new competitors. Since competitors cannot sustain equal or lower prices without incurring losses, they may be forced out of business. After chasing competitors out of the market, the incumbent would have fewer competitors (and may in fact be a monopoly), and can then – in theory – raise prices above what the market would otherwise bear.

In many countries, predatory pricing is considered anti-competitive and is illegal under competition laws. However, It is usually difficult to prove that prices dropped because of deliberate predatory pricing rather than legitimate price competition. In any case, competitors may be driven out of the market before the case is ever heard. Thus, many economists are doubtful that the concept of predatory pricing is actually practical and transferable to the real world.

Economic Rationale

In the short run, profits for the incumbent will fall due to predatory pricing, possibly even into negative territory. The incumbent will not mind so long as they can maintain these losses, which can be made up for once they raise prices above the would-be market level: after the weaker competitors are driven out, the surviving business can raise prices above competitive levels (to supra competitive pricing). The predator hopes to generate revenues and profits in the future that will more than offset the losses it incurred during the predatory pricing period. There must be substantial barriers to entry for new competitors for predatory pricing to succeed. But the strategy may fail if competitors are stronger than expected, or are driven out but replaced by others. In either case, this may force the predator to prolong or abandon the price reductions. The strategy may fail if the predator cannot endure the short-term losses, either because it takes longer than expected or simply because the loss was not properly estimated. So the predator should hope this strategy to works only when it is much stronger than its competitors and when barriers to entry are high. The barriers prevent new entrants to the market replacing others driven out, thereby allowing supra competitive pricing to prevail long enough to dwarf the initial loss.

Criticism and Support

Criticism

Some economists claim that true predatory pricing is rare because it is an irrational practice and that laws designed to prevent it only inhibit competition. This stance was taken by the US Supreme Court in the 1993 case Brooke Group v. Brown & Williamson Tobacco. The Federal Trade Commission has not successfully prosecuted any company for predatory pricing since. Economists argue that the competitors (the ‘prey’) know that the predator cannot sustain low prices forever, so it is essentially a game of chicken. If they can ride it out, they will survive. And even if they cannot, bankrupcy does not by itself eliminate the fallen prey’s ability to produce: the physical plant and people whose skills made it a viable business will exist, and will be available – perhaps at very low prices – to others who may replace the fallen prey once supra-competitive prices set in.Critics of laws against predatory pricing may support their case empirically by arguing that there has been no instance where such a practice has actually led to a monopoly. Conversely, they argue that there is much evidence that predatory pricing has failed miserably.

Support

Prey may not see it as a game of chicken, if they truly believe that the prey has actually found a way to achieve a lower cost of production than them. Thus, they would not know predatory pricing is occurring. They would exit the market, thinking it is no longer profitable. This is known as ‘ low-cost signalling ‘. However, this does not support the idea that the new virtual monopoly could raise and sustain prices at monopoly levels, even though there are certain barriers to entering monopolized markets that could, in theory, prevent the entry of competition.

Examples

According to an International Herald Tribune article, the French government ordered Amazon.com to stop offering free shipping to its customers, because it was in violation of French predatory pricing laws. After Amazon refused to obey the order, the government proceeded to fine them €1,000 per day. Amazon continued to pay the fines instead of ending its policy of offering free shipping. Low oil prices during the 1990s, while being financially unsustainable, effectively stifled exploration to increase production, delayed innovation of alternative energy sources and eliminated competition from other more expensive yet productive sources of petroleum such as stripper wells. It is important to note that in both these and other cases, the predatory pricing policy is alleged, and difficult to prove comprehensively.

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Oil Refinery: In the 1990s, low oil prices were considered a case of alleged predatory pricing.

Price Discrimination

Although there are legal concerns around monopolistic practices, price discrimination is a popular tactic for capturing consumer surplus.

Learning Objectives

Construct the concept of price discrimination relative to legal concerns in pricing

Key Takeaways

Key Points

  • In theoretical markets there exists perfect information, no transaction costs, and perfect substitutes, and in these cases price discrimination can only exist in monopolistic or oligopolistic markets.
  • For price discrimination to take place, companies must be able to identify market segments by their price elasticity of demand, and they must be able to enforce the scheme.
  • There are four degrees of price discrimination (including reverse price discrimination), that all occur under slightly different circumstances, depending on the market structure and the company’s ability to discriminate.

Key Terms

  • consumer surplus: The monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay.
  • price discrimination: Occurs when sales of identical goods or services are transacted at different prices from the same provider.

Price discrimination is the sale of identical goods or services at different prices from the same provider. Price discrimination also occurs when the same price is charged for goods with different supply costs.

Price discrimination’s effects on social efficiency are unclear; typically such behavior leads to lower prices for some consumers and higher prices for others. Output can be expanded when price discrimination is very efficient, but output can decline when discrimination is more effective at extracting surplus from high-valued users than expanding sales to low valued users. Even if output remains constant, price discrimination can reduce efficiency by misallocating output among consumers.

Legal Concerns

Although price discrimination is the producer’s or seller’s legal attempt to charge varying prices for the same product based on consumer demand, price discrimination can be illegal in some cases. For example, it is illegal for manufacturers to set different prices for anti-competitive purposes. Beer companies during the 1960’s attempted to price discriminate based on location to price below competitors and run them out of business.

Economic Rationale

In theoretical markets there exists perfect information, no transaction costs, and perfect substitutes. In these cases price discrimination can only exist in monopolistic or oligopolistic markets: otherwise, a buyer can buy the good at a lower price and sell it immediately at a slightly higher place (but lower than the price discrimination level), making a profit. In the real world, product heterogeneity, market frictions and moderate fixed costs allow for a level of price description in many markets.

Two conditions are necessary for price discrimination:

  1. Companies must be able to identify market segments by their price elasticity of demand;
  2. They must be able to enforce the scheme.

For example, airlines routinely engage in price discrimination by charging high prices for customers with relatively inelastic demand–business travelers –and discount prices for tourists who have relatively elastic demand. The airlines enforce the scheme by making the tickets non-transferable thus preventing a tourist from buying a ticket at a discounted price and selling it to a business traveler (arbitrage). Airlines must also prevent business travelers from directly buying discount tickets. Airlines accomplish this by imposing advance ticketing requirements or minimum stay requirements conditions that would be difficult for average business traveler to meet.

Three curves that show third-degree price discrimination - industry (old profit), elastic submarket (profit), and inelastic submarket (higher profit).

Third Degree Price Discrimination: Instead of supplying one price and taking the profit (old profit) the total market is broken down into two sub-markets. They’re priced separately to maximize profit.

Types of Price Discrimination

First degree

Here, the monopoly seller knows the maximum price each individual buyer is willing to pay, allowing them to absorb the entire consumer surplus. More is produced than the non-discriminating monopoly case, and there is no deadweight loss. This is mostly a theoretical outcome.

Second degree

Price varies according to demand: larger quantities are available at a lower unit price. Unlike first degree, sellers are unable to differentiate between individual consumers, and so they provide incentives for consumers to differentiate themselves. For example, airlines differentiate according to first, business and coach passengers.

Third degree

Price varies by attributes such as location or by customer segment, or in the most extreme case, by the individual customer’s identity; where the attribute in question is used as a proxy for ability/ willingness to pay. Sellers are able to differentiate between different types of consumers. An example is student discounts. In third degree discrimination, it is not always advantageous to discriminate.

Fourth degree/reverse price discrimination

Prices are the same for different customers, even if organizational costs may vary. For example, a coach class airplane passenger may order a vegetarian meal. Their ticket cost is the same, but it may cost more to the airline to obtain a vegetarian meal for them.

Examples of Price Discrimination

Price discrimination is very common in services where resale is not possible; an example is student discounts at museums. Price discrimination in intellectual property is also enforced by law and by technology. In the market for DVDs, DVD players are designed–by law–with chips to prevent an inexpensive copy of the DVD (for example legally purchased in India) from being used in a higher price market (like the US).

Price discrimination can also be seen where the requirement that goods be identical is relaxed. For example, so-called “premium products” (including relatively simple products, such as cappuccino compared to regular coffee) have a price differential that is not explained by the cost of production. Some economists have argued that this is a form of price discrimination exercised by providing a means for consumers to reveal their willingness to pay. For instance, Starbucks will charge more for a coffee than, say, a local cafe, even if there is no discernable difference in quality.

Price Fixing

Price fixing is a collusion between competitors in order to raise prices of a good or service, at the expense of competitive pricing.

Learning Objectives

Examine the characteristics of price fixing and its legal implications

Key Takeaways

Key Points

  • Price fixing is inefficient, transferring some of the consumer surplus to producers and results in a deadweight loss.
  • Price fixing is illegal in most developed countries. In the United States, price fixing can be prosecuted as a criminal federal offense. However, price fixing is perfectly legal in many countries.
  • When sovereign nations rather than individual firms come together to control prices, the cartel may be protected from lawsuits and criminal antitrust prosecution.

Key Terms

  • collusion: A secret agreement for an illegal purpose; conspiracy.
  • price fixing: In antitrust law, collusion between competitors in order to raise prices, at the expense of competitive pricing.
  • deadweight loss: A loss of economic efficiency that can occur when equilibrium for a good or service is not achieved or is not achievable.

As it is commonly understood, the term “price fixing” refers to a collusion between sellers in a market to coordinate pricing—usually pushing it above the competitive level—for their collective benefit. While this is price fixing as commonly understood, the actual definition is much broader. It is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand. The defining characteristic of price fixing is any agreement regarding price, whether expressed or implied. The intent of price fixing may be to push the price of a product as high as possible, leading to profits for all sellers but may also have the goal to fix, peg, discount, or stabilize prices.

There are many things sellers may do during a price fix. They might agree to sell at a common target price, set a common minimum price, buy the product from a supplier at a specified maximum price, adhere to a price book or list price, engage in cooperative price advertising, standardize financial credit terms offered to purchasers, use uniform trade-in allowances, limit discounts, discontinue a free service or fix the price of one component of an overall service, adhere uniformly to previously announced prices and terms of sale, establish uniform costs and markups, impose mandatory surcharges, purposefully reduce output or sales in order to charge higher prices, or purposefully share or pool markets, territories, or customers. These are all instances of price fixing.

Economic Argument and Legal Status

In neoclassical economics, price fixing is inefficient, transferring some of the consumer surplus to producers and results in a deadweight loss. Because of this, price fixing is illegal in most developed countries. In the US, price fixing can be prosecuted as a criminal federal offense. Under American law, even exchanging prices among competitors can violate the antitrust laws. This includes exchanging prices with either the intent to fix prices or if the exchange affects the prices individual competitors set.

In countries other than the United States, Canada, Australia, New Zealand, Japan, Korea and within the European Union, price fixing is not usually illegal and is often practiced. When the agreement to control price is sanctioned by a multilateral treaty or is entered by sovereign nations as opposed to individual firms, the cartel may be protected from lawsuits and criminal antitrust prosecution. This explains, for example, why OPEC, the global petroleum cartel, has not been prosecuted or successfully sued under US. antitrust law. International airline tickets have their prices fixed by agreement with the IATA, a practice for which there is a specific exemption in antitrust law.

Prominent Price Fixing Examples

Air Travel

In August 2007 British Airways was fined £121.5 million for price fixing. The fine was imposed after BA admitted to the price fixing of fuel surcharges on long haul flights. The allegation first came to light in 2006 when Virgin Atlantic reported the events to the authorities after it found staff members from BA and Virgin Atlantic were colluding. Virgin Atlantic has since been granted immunity by both the Office of Fair Trading and the United States Department of Justice who have been investigating the allegations since June 2006. The US Department of Justice later announced that it would fine British Airways $300 million (£148 million) for price fixing. BA maintained that fuel surcharges were “a legitimate way of recovering costs. ”

Beer

In April 2007 the European commission fined Heineken €219.3m, Grolsch €31.65m and Bavaria €22.85m for operating a price fixing cartel in Holland, totalling €273.7m (InBev, another brewer, was convicted for price fixing but escaped punishment). The brewers controlled 80% of the Dutch market, with Heineken claiming 50% and the two others 15% each. Neelie Kroes said she was “very disappointed” that the collusion took place at the very highest (boardroom) level. She added, Heineken, Grolsch, InBev and Bavaria tried to cover their tracks by using code names and abbreviations for secret meetings to carve up the market for beer sold to supermarkets, hotels, restaurants and cafes. The price fixing extended to cheaper own-brand labels and rebates for bars.

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Heineken : Heineken was fined 219.3 million euro for its role in a price fixing cartel in Holland in 2007.