Price Discrimination Essay, Research Paper

Definition of Price Discrimination

Price discrimination takes place when a seller charges competing buyers different prices for the same commodity or discriminating in the provision of allowances Xcompensation for advertising and other services Xthat may be violating the Robinson-Patman Act. This kind of price discrimination may hurt competition by giving favored customers an edge in the market that has nothing to do with the superior efficiency of those customers.

The Robinson-Patman Act

The Robinson-Patman Act, enacted by Congress in 1936, is concerned with discrimination in the prices charged by sellers to various customers. More business decisions are affected by the Act than any other antitrust law. Virtually every interstate sale and promotion of commodities through wholesale distribution and other channels is subject to its terms.

This law, like other antitrust laws, introduces uncertainty and complexity into the day-to-day operation of business. However, compliance with the antitrust laws is not an option. Therefore, a basic understanding of these laws is necessary for the business person who must comply with its requirements and meet the business challenges presented in today s highly competitive markets. Finally, states have enacted laws, which complement the federal law and in some cases impose additional limits on pricing practices. These laws must also be observed when applicable to business activities.

Provisions of the Law

The Robinson-Patman Act prohibits price discrimination in certain circumstances. The Act requires allegedly discriminatory transactions to satisfy certain jurisdictional prerequisites before its substantive prohibitions apply. In order to bring the substantive portions of the Act into play, there must be:

h Two or more consummated sales in commerce

h Reasonably close in point of time

h Of commodities

h Of like grade and quality

h With a difference in price

h By the same seller

h To two or more different purchasers

h For use, consumption, or resale within the United States, and

h Which may result in competitive injury

Competitive Injury Must be Present

The Act contains a number of separate substantive provision applicable the competitive injury element of an offense. Section 2(a) prohibits a seller from discriminating in price between two or more competing purchasers in the sale of commodities of like grade and quality, where the effect of the discrimination may be substantially to:

h Lessen competition in any line of commerce; or

h Tend to create a monopoly in any line of commerce; or

h Injure, destroy, or prevent competition with any person who grants or knowingly receives the benefit of the discrimination, or with the customers of either of them.

U.S. Supreme Court Case

Texaco Inc. v. Hasbrouck, 496 U.S. 543 (1990)

Argued December 5, 1989

Decided June 14, 1990

Petitioner (Texaco) sold gasoline directly to respondents and several other retailers in Spokane, Washington, at its retail tank wagon prices (RTW) while it granted substantial discounts to two distributors, Gull and Dompier. During the period between 1972 and 1981, the stations supplied by the two distributors increased their sales volume dramatically, while respondents’ sales suffered a corresponding decline. Respondents filed an action against Texaco under the Robinson-Patman Amendment to the Clayton Act (Act), alleging that the distributor discounts violated Section 2(a) of the Act. Respondents recovered treble damages, and the Court of Appeals for the Ninth Circuit affirmed the judgment. After this happened Texaco appealed to the U.S. Supreme Court and the trial was heard.

Texaco tried to argue that legitimate functional discounts do not violate the Act because a seller is not responsible for its customers’ independent resale pricing decisions. While the Supreme Court agreed with the basic thrust of Texaco’s argument, it concluded that in this case it was foreclosed by the facts of record. 3

This was a pretty clear cut price discrimination case. Obviously if Texaco sells the gas at, for example, $5 a gallon to one company and $20 to another the first company is at a great advantage since it could sell the gas at a cheaper price. Which would mean more customers and, thus, more profit. Therefore, Texaco is definitely partially if not fully responsible for its customers independent resale pricing decisions.

Defenses to Price Discrimination

Not all price differences are illegal. The Robinson-Patman Act contains a number of exceptions to the prohibitions embodied in section 2(a).

The Cost Justification Defense

The cost justification defense allows a seller to discriminate in prices where the difference makes only due allowance for differences in cost of manufacture, sale or delivery resulting from the differing methods or quantities in which the buyers are supplied. For example, if one buyer has special need that must be addressed in manufacture, such as an additional part to a gadget, that buyer can be charged for the additional cost. Likewise, adjustments may be made legally for higher or lower selling costs or delivery costs.

The Meeting Competition Defense

The meeting competition defense provides that a seller acting in good faith to meet an equally low price of the competitor may legally discriminate in price. Manufacturers, suppliers and sellers are urged to take care when dealing with dealers, distributors, value added resellers, retailers and other involved in the chain of distribution. Different prices for two similar buyers may violate the Robinson-Patman Act.4

Changed Conditions

The Act permits price differences due to changing conditions affecting the market or the marketability of the goods concerned, such as the deterioration of perishable goods, the obsolescence of seasonal goods, distress sales under court process, or bona fide going out of business sales.4

Final Thoughts on Robinson-Patman Act

The Robinson-Patman Act does not prohibit all price differences and it is not intended to protect businesses from all competitive disadvantage. The courts and the Federal Trade Commission (FTC) have recognized, in particular, that the Act permits price differences that can be justified on the basis of cost differences attributable to cost advantages to the seller, or that result from efforts by a seller to meet the competition of other sellers.

The courts have further recognized that the Act permits a seller to grant functional discounts to certain purchasers as due recognition and reasonable reimbursement for distribution and marketing functions actually performed by the purchaser. Finally, a price discrimination will not constitute a violation of the Act unless the price discrimination produces the actual requisite degree of actual or threatened competitive injury as described above.4

U.S. Supreme Court Case

Falls City Industries v. VANCO Beverage, 460 U.S. 428 (1983)

Argued October 13, 1982

Decided March 22, 1983

During a certain period from 1972 through 1978, petitioner(Falls City Industries) sold its beer to respondent, the sole wholesale distributor for petitioner’s beer in Vanderburgh County, Ind., at a higher price than petitioner charged its only wholesale distributor in Henderson County, Ky., the two counties forming a single metropolitan area across the state line. Respondent filed suit in Federal District Court, alleging that petitioner’s price discrimination violated 2(a) of the Clayton Act, as amended by the Robinson-Patman Act. The court rejected petitioner’s “meeting-competition” defense under 2(b) of the Clayton Act, which provides that a defendant may rebut a prima facie showing of illegal price discrimination by establishing that its lower price to any purchaser or purchasers “was made in good faith to meet an equally low price of a competitor.” The court reasoned that instead of reducing its prices to meet those of a competitor, petitioner had created the price disparity by raising its prices to wholesalers; that instead of adjusting prices on a customer-to-customer basis to meet competition from other brewers, petitioner charged a single price throughout each State; and that the higher price was not set in good faith but instead was raised solely to allow petitioner to follow other brewers to enhance its profits. The Court of Appeals affirmed. The U.S. Supreme Court made the following judgment: Accordingly, the judgment of the Court of Appeals is vacated, and the case is remanded for further proceedings consistent with this opinion. 3

In this Court Case it is evident that defenses to price discrimination are very tough to prove because so many different factors play a role in them. The petitioners case was mainly based on the Meeting Competition defense. And they failed to prove their defense because of inconsistency of their argument with the actual definition of the Meeting Competition defense. They raised their prices instead of lowering them, instead of adjusting prices on a customer-to-customer basis, petitioner charged a single price throughout each State; and the higher price was not set in good faith but instead was raised solely to allow petitioner to follow other brewers to enhance its profits.

Degrees of Price Discrimination

Price discrimination can take three broad forms: first-, second-, and third-degree price discrimination.

First-Degree Price Discrimination

First-degree price discrimination allows pricing at the level at which every individual is willing to pay. That is, the seller charges every individual his of her reservation price, the maximum price he/she is willing to pay.

In practice, perfect first-degree price discrimination is almost never possible. First, it is usually impractical to charge each and every customer a different price (unless there are only a few customers). Second, a firm usually does not know the reservation price of each customer. Even if the firm could ask how much each customer would be willing to pay, it probably would not receive honest answers. After all, it is in the customers interest to claim that they would pay very little.

Sometimes, however, firms can discriminate imperfectly by charging a few different prices based on estimates of customers reservation prices. This happens frequently when professional, such as doctors, lawyers, accountants, or architects, who know their clients reasonably well, are the firms. Then the client s willingness to pay can be assessed, and fees set accordingly. For example, a doctor may offer a reduced fee to a low-income patient whose willingness to pay or insurance coverage is low, but charge higher fees to upper income or better-insured patients. And an accountant, having just completed a client s tax return, is in an excellent position to estimate how much the client is willing to pay for the service.5

Another example is a car salesperson, who typically works with a 15 percent profit margin. The salesperson can give part of this away to the customer by making a deal, or can insist that the customer pay the sticker price for the car. The customer who is likely to leave and shop around receives a big discount because from the salesperson s point of view, a small profit is better than no sale and no profit. But the customer in a hurry is offered little or no discount.5

Second-Degree Price Discrimination

Second-degree price discrimination is discrimination through block pricing over time, or discrimination with respect to quantity purchased. In some markets, each consumer purchases many units of the goods over any given period, and the consumer s demand declines with the number of units purchased. Examples include water, heating fuel, and electricity. Consumers may each purchase a few hundred kilowatt-hours of electricity a month, but their willingness to pay declines with increasing consumption. (The first hundred kilowatt-hours may be worth a lot to the consumer Xoperating a refrigerator and providing for minimal lighting. Conservation becomes easier with the additional units, and may be worthwhile if the price is high.) Often state agencies that control the company s rates may encourage block pricing. By expanding output and achieving greater scale economies, consumer welfare can be increased, even allowing for greater profit to the company. The reason is that prices are reduced overall, while the savings from the lower unit costs still permit the power company to make a reasonable profit.5

Third-Degree Price Discrimination

Third-degree price discrimination divides consumers into groups of two or more with separate demand curves for each group. This is the most prevalent form or price discrimination, and examples abound: regular versus special airline fares; the premium versus nonpremium brand of liquor, canned food or frozen vegetables; discounts to students and senior citizens; etc.

In each case, some characteristic is used to divide consumers into distinct groups. For example, for many goods, students and senior citizens are usually willing to pay less on average than the rest of the population (due to lower incomes). Likewise, to separate vacationers from business travelers (whose companies are usually willing to pay much higher fares), airlines can put restrictions on special low-fare tickets, such as requiring advance purchase. With liquor company, or the premium versus nonpremium brand of food, the label itself divides consumer; many consumers are willing to pay more for a name brand, even though the nonpremium brand is identical or nearly identical.5

Intertemporal Price Discrimination and Peak-Load Pricing

Intertemporal price discrimination is an important and widely practiced pricing strategy closely related to third-degree price discrimination. Here consumers are separated into different groups with different demand functions by being charged different prices at different points in time.

To see how intertemporal price discrimination works lets think about how an electronics company might price new, technologically advanced equipment, such as videocassette recorders during the 1970s, compact disc player in the early 1980s, and DVD players at the present time. The strategy is to initially offer the product at the high price selling mostly to consumers who value the product highly and do not want to wait to buy it. Later, after this group of consumers has bought the product, the price is lowered and sales are made to the larger group of consumers who are more willing to forgo the product if the price is too high.6

There are other examples of intertemporal price discrimination. One involves charging a high price for a first-run movie, then lowering the price after the movie has been out a year. Another, practiced almost universally by publishers, is to charge a high price for the hardcover edition of a book, and then to release the paperback version at a much lower price about a year later.6

Peak-load pricing is a form of intertemporal price discrimination based on efficiency. For some goods and services, demand peaks at particular times Xfor roads and tunnels during commuter rush hours, for electricity during late summer afternoons, and for ski resorts and amusement parks on weekends. Prices are thus higher during peak periods. Other examples of peak-load pricing include, the difference in movie ticket prices for the evening and matinee shows and price difference in tickets for public garages on weekends and weekdays.6

The Two-Part Tariff

The two-part tariff system charges a fixed fee of entry to the consumer to extract a portion of his/her surplus and in turn charges the consumer a price per utilization. The classic example of this is an amusement park. The consumer pays an admission fee to enter, and also pays a certain amount for each ride he/she goes on.

The two-part tariff has been applied in many settings: tennis and golf clubs, where the consumer pays an annual membership fee, plus a fee for each use of a court or round of golf; the rental of large mainframe computers where the consumer pays a flat monthly fee plus a fee for each unit of processing time consumed; a Polaroid camera , where the consumer pays for the camera, which lets you productively consume the film, which he/she pays for by the package; and safety razors, where the consumer pays for the razor, which lets him/her consume the blades that fit only that brand of razor.7

Conclusion

Price discriminations generally are lawful, particularly if they reflect the different costs of dealing with different buyers or result from a seller s attempts to meet a competitor s prices or services. But since price discrimination also might be used as a predatory pricing tactic — setting prices below cost to certain customers — to harm competition at the supplier s level, antitrust authorities use the same standards applied to predatory pricing claims under the Sherman Act and the FTC Act to evaluate allegations of price discrimination used for this purpose.