PRICING AND SALES PROMOTION:LEGAL ISSUES IN PRICING

7. LEGAL ISSUES IN PRICING

The development of a price structure to implement a pricing strategy is not only a difficult and complex task but is fraught with the potential for violating federal and state laws. In fact, the legal aspects of pricing strategy comprise one of the most difficult parts of marketing strategy and have left many business people not only frightened of making pricing decisions but often vulnerable to legal action because of their pricing activities.

As indicated earlier, the short-term effects of reducing price on profits likely will not be positive. Yet many firms attempting to gain volume or market share often resort to price reductions. Other competing firms often feel compelled to follow these price reductions and often to undercut the original price-reducing firm. Also, there is pressure, real or perceived, to provide certain buyers a favored status by giving them additional discounts for their business. To counteract these pressures to reduce prices and stabilize profits, some businesses have attempted by either overt or covert actions to stabilize prices and market share. In other situations, a larger firm has aggressively reduced prices in one market area or to a specific set of customers in order to reduce competition or drive a competitor out of business. Moreover, we have suggested that there are typically several price-market segments distinguished by different degrees of sensitivity to prices and price differences. Thus, the opportunity exists to set different prices or to sell through different channels to enhance profits.

Each of these various possible strategies or tactics is covered by some form of legislation and regulation. In fact, there are laws concerning price fixing amongst competitors, exchanging price information or price signalling to competitors, pricing similarly to competitors (parallel pricing), predatory pricing, and price discrimination. This section briefly overviews the laws that cover these types of activities.

Price Fixing

The Sherman Antitrust Act (1890) specifically addresses issues related to price fixing, exchanging price information, and price signaling. It also has an effect on the issue of predatory pricing. Section 1 of the Act prohibits all agreements in restraint of trade. Generally, violations of this section are divided into per se violations and rule of reason violations. Per se violations are automatic. That is, if a defendant has been found to have agreed to fix prices, restrict output, divide markets by agree- ment, or otherwise act to restrict the forces of competition, he or she is automatically in violation of the law and subject to criminal and civil penalties. There is no review of the substance of the situation, that is, whether there was in fact an effect on competition. In contrast, the rule-of-reason doctrine calls for an inquiry into the circumstances, intent, and results of the defendants’ actions. That is, the

courts will examine the substantive facts of the case, including the history, the reasons for the actions, and the effects on competition and the particular market. The current attitude of federal and state agencies and courts is that price fixing is a per se violation and that criminal sanctions should be applied to the guilty persons.

Section 2 of the Act prohibits the act of monopolizing, that is, the wrongful attempt to acquire monopoly power. Thus, having a monopoly is not illegal, but the deliberate attempt to become a monopoly is illegal. The issue here in recent cases has been not whether a firm had acquired a monopoly per se, but the methods of achieving such market power. Thus, the courts have been somewhat more aware of a firm’s need to develop a strong competitive position in the markets it serves and that these strong competitive actions may lead to dominant market shares. However, if this dominant market share leads to above-market-average prices, some form of legal or regulatory action may take place.

Exchanging Price Information

Many trade associations collect and disseminate price information from and to their members. The legal issue arises when there is an apparent agreement to set prices based on the exchanged price information. Thus, if members discuss prices and production levels in meetings and prices tend to be uniform across sellers, it is likely that the exchange of information led to some form of price fixing. Again, the issue is whether the exchange of price information seems to have the effect of suppressing or limiting competition, which is a violation of section 1 of the Sherman Act. Care must be exercised about when and how price information is exchanged by competing sellers. The trend in recent years has been to make it more difficult to prove that such exchanges do not violate section 1.

Parallel Pricing and Price Signaling

In many industries and markets, one firm may emerge as a price leader. That is, one firm often is the first to announce price changes, and most rival sellers will soon follow the price changes made by the leader. At other times, another firm may initiate the price changes, but if the price leader does not introduce similar price changes, the other firms as well as the initial firm will adjust their prices to correspond to the price leader’s prices. The legal question arises as to whether these somewhat concerted prices and price changes constitute a tacit, informal, and illegal agreement in violation of section 1.

Recently, some questions have been raised as to whether the public announcement of prices and price changes has been used by sellers to signal prices and achieve this common understanding about prices. That is, do sellers achieve this common understanding about prices through public announce- ments about their prices and price changes? If so, then a violation of section 1 may exist. For example, if one company announces a price increase effective 60 days later, some legal people have suggested that the announcement serves as a signal to competition. The suggestion seems to imply that if others follow with similar announcements, then the price increase will remain in effect; if others do not follow, the price increase will be rescinded. Announcing price increases ahead of the effective date provides time for customers, distributors, and the sales force to adjust their price frame of reference. However, what may be an effective managerial practice could be interpreted as a mechanism for attempting to achieve a common understanding among rival sellers. The ramifications of price sig- naling from a legal perspective remain to be determined by either legislative action, litigation, or further debate.

Predatory Pricing

Predatory pricing is the cutting of prices to unreasonably low and / or unprofitable levels so as to drive competitors from the market. If this price cutting is successful in driving out competitors, then the price cutter may have acquired a monopoly position via unfair means of competition—a violation of section 2 of the Sherman Act.

There is considerable controversy about predatory pricing, particularly how to measure the effect of a low-price strategy on the firm’s profits and on competitors. Predatory pricing occurs whenever the price is so low that an equally efficient competitor with smaller resources is forced from the market or discouraged from entering it. Primarily, the effect on the smaller seller is one of a drain on cash resources, not profits per se. Much of the controversy surrounding measuring the effects of an alleged predatory price relates to the proper set of costs to be used to determine the relative profitability of the predator’s actions. Recently, the courts seem to have adopted the rule that predatory pricing exists if the price does not cover the seller’s average variable or marginal costs. However, the intent of the seller remains an important consideration in any case.

Illegal Price Discrimination

The Robinson-Patman Act was passed in 1936 to protect small independent wholesalers and retailers from being charged more for products than large retail chains were. Sellers can, however, defend

themselves against discrimination charges by showing that their costs of selling vary from customer to customer. Cost savings can then be passed along to individual buyers in the form of lower prices. The Robinson-Patman Act therefore permits price discrimination in the following cases:

1. If the firm can demonstrate that it saves money by selling large quantities to certain customers, it can offer these buyers discounts equal to the amount saved.

2. Long-term sales agreements with customers also reduce costs; again, discounts may be granted equal to the amount saved.

3. In cases where competitors’ prices in a particular market must be met, it is legal to match the competitors’ lower prices in such a market while charging higher prices in other markets.