September 15 , 2002
Anti-Competitive Impacts of Secret Strategic Pricing in the Electricity Industry
cut prices particularly deeply in some parts of the market, sometimes even down to "predatory" levels, which are below cost. This action can send signals of "credible threats" of future decisive price cuts, which deters future potential competitors. By making extra money in the future from deterring many other rivals, the dominant firm can gain profit even when its prices against one rival seem to lose money. Deep price cutting can be entirely rational.
Discrimination can block the emergence of competition
During the attempt to deregulate a former monopoly and move it toward effective competition, the monopoly's resort to strategic pricing may be especially strong and frustrating. In its previous franchised-monopoly period, the established firm has usually adopted discrimination reflecting the variations in demand elasticities. Even (or especially) if the regulators have let the utility firm adopt such discriminatory prices already, the firm usually has an extensive knowledge of the elasticities and the customers' response patterns.
As soon as public policy shifts from natural-monopoly regulation to open access and promoting competition, the same monopoly firm's pricing structure is transformed from static efficiency-promoting to competition-blocking. Even if the price structure may have promoted efficient allocation under natural monopoly, it becomes a deadly weapon for containing and fighting little rivals. The regulators must shift their thinking and their policies diametrically: The discrimination has changed from a largely favorable pattern to an anti-competitive weapon, which may prevent effective competition.
Remember, strategic price discrimination can be quite healthy and pro-competitive, but only if the situation already is strongly competitive. Indeed, the discounting is a common, crucially valuable part of the competitive process; flexible price discounting can be the life-blood of competition.
But that benign effect occurs only where the firms doing the discounting have only small market shares and where there is no substantial market power. In such a situation, discounting and discrimination is just another way to win business, and no firm can use it widely and deeply enough to suppress healthy competition.
The applications to the electricity industry are clear and important. The former franchised-monopoly utilities naturally will resort to dynamic discrimination with the onset of competition. Left unchecked, discrimination may be used to stop or slow down the rise of competition. Therefore, regulators need to take special care to prevent firms from using this pricing weapon before and during the transition. When and if competition is fully established (em and only then (em discrimination will pose no anti-competitive threat.
There is widespread evidence that electric utilities are already deeply involved in this type of strategic pricing, which started several years ago in some states. A newspaper account in April 1996 noted that in more than four states (em Massachusetts, New York, Michigan and California (em large-customer discounts had been applied already (see table 1).
In some cases, the discounts were explained as being merely a response to the customers' threat to move elsewhere. Those are now known as "business-retention" or "load-retention" discounts (or to "prevent uneconomic by-pass"). In other cases, the discounts apparently are done at the initiative of the utility