Professor Shepherd sees selective price cutting as anti-competitive, but even a monopolist should be allowed to compete on price.

As the electric industry deregulates, state public utility commissions are asked increasingly to allow the local utility to offer price discounts to large-load customers who might otherwise turn to other sellers. So far, nearly all the PUCs faced with this issue have agreed that such discounts are beneficial: They help retain large-load customers, who help pay the utility's fixed costs. Without that contribution, a heavier cost burden would fall on those customers who remain. Professor William G. Shepherd, on the other hand, views this consensus with dread and alarm. %n1%n He argues that regulators must reverse the present trend and forbid utilities from offering discounts to large-load customers. He predicts that, if left unchecked, strategic discounts may stifle competition in a deregulated electricity market.

Professor Shepherd's doomsday forecast is in error. His thesis rests on a misunderstanding of the electric market and misapplies the principles of antitrust law. In reality, strategic discounts promote competition. They play an important role in easing the transition to a deregulated market.

Moreover, Professor Shepherd loses sight of the ultimate goal of the antitrust laws (em to protect the competitive process and the interests of consumers. %n2%n Discounts benefit both the customers to which they are offered and the other ratepayers of the utility.

Of course, one could perhaps envision a predatory discount (em a price set below costs specifically to force out rivals (em but that case would imply market power, and Professor Shepherd has shown no example of such conduct. This unlikely prospect should give no reason to abandon a practice that has served the interests of electricity consumers. Instead, specific abuses can be addressed through the present regulatory environment or, following deregulation, through governmental or private enforcement of the antitrust laws. Allowing utilities to compete to retain large customers leads to more effective competition and promotes the interests of electricity consumers generally.

Many States

Have Given Approval

As of today, approximately 20 states have allowed electric utilities to offer some form of discount to large-load customers that might otherwise leave the system. These states include: Alabama, Alaska, Arizona, Arkansas, California, Connecticut, Idaho, Illinois, Indiana, Maine, Massachusetts, Michigan, Missouri, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio and Washington. Several of these states, including Connecticut, %n3%n Maine %n4%n and Massachusetts, %n5%n have passed statutes that expressly authorize such discounts. Many other regulatory commissions have approved special contracts following regulatory proceedings, which have often included briefing and hearing. %n6%n

Commissions often require utilities to meet certain conditions before offering price discounts. First, in most cases, the utility must prove the customer would leave its system if not offered the discount. Second, in most cases, the utility must show that, even with the discount, the price charged to the large customer will still contribute sufficiently to fixed-cost recovery, which would benefit other utility customers. In the alternative, the utility must show that the discount will not harm other ratepayers. %n7%n

Promoting Important Regulatory Interests

Most states that have approved discounts limit their application: The discount must be required for business retention. This condition is neither an idle nor speculative concern. Many utilities encounter problems retaining large customers. In a growing number of cases, a utility has lured away a large customer with a seemingly less-expensive or more appealing alternative source of electricity. The tug of these alternatives will only grow greater as competition for customers increases. Later, as competitive alternatives become increasingly available, even the utility's smaller customers will leave. What was once the dominant utility may soon go the way of the dinosaur. In a very real sense, even when a utility enjoys a "dominant" share of the market today it must engage in price

competition to remain a viable competitor. The purpose of the discount is not to entrench the dominant local suppliers of electricity at the expense of potential competitors, nor to cause injury to smaller customers. However, if a utility is prohibited from taking steps to keep its larger customers, those customers will leave.

Are discounts a sort of "Devil's Pact" between utilities and their largest customers? On the contrary; discounts serve legitimate commercial interests. It is wrong to assume that any discount given by a utility to retain large-load customers will harm customers that do not receive a discount. In fact, a substantial body of law shows that the contrary is true; discounts to large customers generally lead to lower rates for other customers of the utility. %n8%n

Commissions have recognized that if a large customer leaves a utility, that customer will no longer contribute to the utility's fixed costs. As more big customers leave, smaller ratepayers will bear a larger and larger share of the utility's fixed costs. Those customers with the fewest competitive alternatives, including residential and low-income users, will be hit hardest by these greater costs. If a utility cannot offer a discount to keep its large customers, it may become saddled with "uneconomic bypass." A discount that enables the utility to retain its large customers benefits all customers of the utility. Indeed, a review of the decisions approving discounts shows many instances where regulators have insisted on a showing that small customers will benefit from the discount. %n9%n

Discounts do not destroy emerging competition. Smaller and more vulnerable firms will not likely emerge as the only new rivals for market share. The local utility may find that its greatest rival comes from outside its service territory, in the form of another utility from an adjacent territory or from out of state. Any fears that discounts offered by the local utility may "quell or kill specific rivals in market niches" are unfounded. For example, a company in Minneapolis may be enticed to buy its electricity from a Wisconsin utility rather than its local utility. That rival utility may prove bigger and more established. The rival utility might underprice the local utility because it has lower expenses or fixed costs. A more modern or efficient infrastructure might allow it to offer superior service. However, if the local utility can offer a discount, it might still compete with the rival. In such instances, the customer will benefit from receiving the best possible price and term (em a result of competition. By contrast, if the local utility cannot offer a discount, it will lose its ability to effectively compete, and the rival will lure away its customers.

Indeed, even a newer entrant may not face a disadvantage when competing against the local utility. In many cases, the new firm may avoid incurring the significant fixed costs that the utility had to bear to meet customer needs and provide universal service. As a result, newer entrants may be able to offer better prices, more innovative service or unusual specialties not offered by traditional utilities.

Meshing With

Antitrust Law

Price discounts usually do not pose a concern even where the seller holds a monopoly. To the contrary, the concern is that the monopolist will force higher costs, reduce output or offer poor service. %n10%n In addition, the position that utilities should not be able to offer discounts runs counter to the recognized view that even a monopolist should be allowed to compete on the basis of price %n11%n and reduce its price in order to retain customers that might otherwise be lost. %n12%n

Discounts do not often fall below cost, where they would become predatory. The present regulatory environment imposes safeguards to prevent that from happening. Indeed, in the present market for electricity, it would prove very difficult for a local utility to engage in predatory pricing through discounts. For pricing to be "predatory," a seller with market power must reduce its prices below its cost (usually its average variable cost) with the specific intent, first of forcing its rivals to leave the marketplace, and, following this, of recouping its short-run losses by imposing monopoly rents. %n13%n

If a utility should lower prices to force out rivals, consumers would only benefit from lower rates. Even if certain rivals temporarily left the market, competition would not suffer until the utility tried to charge monopoly rents. %n14%n Once it did so, however, rivals from outside the market would have every reason to enter the market and underprice the utility. The ease with which these firms could enter from outside the market would act as a check on the ability of the utility to extract supra-competitive profits. In the end, any effort by a utility to engage in predatory conduct might well only produce losses for its shareholders. %n15%n

A discount offered by a utility to a large-volume customer is not a form of anti-competitive price discrimination. This analysis is inconsistent with theories of price discrimination developed under the antitrust laws and, in particular, the Robinson-Patman Act (15 U.S.C. §13a). To begin with, there remains a dispute among courts as to whether electricity is even a commodity subject to Robinson-Patman. %n16%n But assuming such pricing is discriminatory (em even when offered to retain a large customer (em it still would not be unlawful under Robinson-Patman. Rather, such conduct would be protected under the "meeting competition" defense to the act. Under that defense, if a customer is offered a special deal by a competitor, a company, dealing in good faith, can meet that competitor's terms to retain that customer even if the same terms were not offered to its other customers. %n17%n This defense is specifically written into the text of the Robinson-Patman Act. %n18%n

Despite the hue and cry raised against special contract discounts, opponents have yet to muster proof that such discounts injure customers. t

Paul F. Hanzlik is a partner at Hopkins & Sutter, where he specializes in representing electric utilities with respect to demonstrating the prudence of management conduct, emerging competitive issues and certification of new energy facilities. David B. Goroff is a partner at Hopkins & Sutter, where he specializes in antitrust law with a particular focus on deregulated industries.

1William G. Shepherd, "Anti-Competitive Impacts of Secret Strategic Pricing in the Electricity Industry," PUBLIC UTILITIES FORTNIGHTLY, Feb. 15, 1997, p. 24.

2See Brunswick Corp. v. Pueblo Bowl-O-Mat, 429 U.S. 477, 489 (1977).

3Conn.Gen.Stat. §16-19hh (1994).

435-A M.R.S §3195 (1995).

5Massachusetts Ann. Laws, Ch. 164, §94 (1996).

6See, e.g., In re Homer Electric Association Inc., 101 PUR4th 14 (Docket No. U-88-25, Alaska PUC, Feb. 28, 1989); In re Southern California Edison Co., 150 PUR4th 271 (Decision 94-03-075, Cal.PUC, Mar. 16, 1994); In re Competitive Opportunities Available to Customers of Electric and Gas Service, 145 PUR4th 267 (Case 93-M-0229, N.Y.PSC, June 30, 1993).

7See, e.g., In re Pacific Gas & Electric Co., 39 CPUC 2d 540 (Decision 91-04-060, Cal. PUC, Apr. 24, 1991) (rejecting a special contract discount where a utility could not demonstrate that other ratepayers would not be adversely affected).

8See, e.g., In re Southern California Edison Co., 53 CPUC 2d 663 (Decision 94-03-075, Cal. PUC, Mar. 16, 1994) (The Commission found that "[t]he agreement provides a significant benefit to other Edison customers by retaining Edison's largest single-site customer, who will make a positive contribution to Edison's fixed costs.")

9See, e.g., In re Alabama Power Co., 168 PUR4th 513 (Informal Docket No. U-3672, Alabama P.S.C., Apr. 1, 1996).

10United States v. Grinnell Corp., 384 U.S. 563, 571 (1966).

11See, e.g., Bayou Bottling, Inc. v. Dr. Pepper Co. 543 F.Supp. 1255, 1266 (W.D.La.1982) ("Even a monopolist is allowed to meet competition by promoting its own product"), aff'd, 725 F.2d 300 (5th Cir.), cert. denied, 469 U.S. 833 (1984); Northeastern Tel. Co. v. AT&T, 651 F.2d 76, 93 (2d Cir. 1981) ("Even monopolists must be allowed to do as well as they can with their business."), cert. denied, 455 U.S. 943 (1982); Superturf, Inc. v. Monsanto Co., 660 F.2d 1275, 1280 (8th Cir. 1981) ([A monopolist] "may ... aggressively compete in the marketplace").

12See, e.g., Olympia Equip. Leasing v. Western Union Telegraph 797 F.2d 370, 375 (7th Cir.1986) ("Today it is clear that a firm with lawful monopoly power has no general duty to help its competitors, whether by holding a price umbrella over their heads or by otherwise pulling its competitive punches."), cert. denied, 480 U.S. 934 (1987); Foremost Pro Color, Inc. v. Eastman Kodak Co. 703 F.2d 534, 544 (9th Cir. 1983) ("A monopolist, no less than any other competitor, is permitted and indeed encouraged to compete aggressively on the merits..."), cert. denied, 465 U.S. 1038 (1984); Austin v. Blue Cross & Blue Shield of Alabama, 903 F.2d 1385, 1390 (11th Cir. 1990) (using market power to obtain lower prices for Blue Cross subscribers was not anti-competitive).

13Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574 (1986); Areeda & Turner, Predatory Pricing and Related Practices under Section 2 of the Sherman Act, 88 HARV. L. REV. 697, 711, 716-18 (1975).

14See Brooke Group, Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993).

15See generally Easterbrook, Predatory Strategies and Counterstrategies, 48 U. CHI. L. REV. 263 (1981).

16Compare City of Kirkwood v. Union Electric Co., 671 F.2d 1173, 1181-82 (8th Cir. 1992), cert. denied, 459 U.S. 1170 (1983), with City of Newark v. Delmarva Power & Light Co., 467 F. Supp. 763, 772-74 (D. Del. 1979).

17See also Bristol Steel & Ironworks, Inc. v. Bethlehem Steel Corp., 41 F.3d 182, 188

(4th Cir.1994).

1815 U.S.C. §13a.

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