Legal Definitions - price/cost analysis

Price/Cost Analysis

Price/cost analysis is a specialized technique used within antitrust law (also known as competition law) to investigate whether a dominant company is engaging in predatory pricing. Predatory pricing occurs when a company intentionally sets its prices extremely low, often below its own production costs, with the aim of driving competitors out of the market and then raising prices once competition is eliminated.

This analysis involves a detailed examination of the relationship between a company's selling prices for its products or services and its underlying costs. Specifically, it compares prices to either the company's average variable cost (costs that change directly with the level of production, like raw materials or direct labor) or its average total cost (which includes both variable costs and fixed costs, like rent or equipment depreciation).

Here are some examples:

• Example 1: Software Subscription Service

  A large, established technology company, which dominates the market for productivity software, launches a new cloud storage subscription service. To quickly gain market share and potentially eliminate smaller, specialized cloud storage providers, it offers its premium subscription at a price significantly lower than what it costs the company to provide the service, including server maintenance, data transfer, and customer support.

  How it illustrates the term: Antitrust regulators would conduct a price/cost analysis. They would compare the subscription fee charged by the dominant tech company to its average variable costs (e.g., electricity for servers, bandwidth usage per user) and average total costs (including the depreciation of data centers and software development). If the price is found to be consistently below these cost benchmarks, it could indicate predatory pricing aimed at monopolizing the cloud storage market.

• Example 2: Pharmaceutical Drug Pricing

  A pharmaceutical giant holds a patent for a life-saving drug. After the patent expires, several generic drug manufacturers enter the market, offering the drug at much lower prices. In response, the pharmaceutical giant drastically cuts the price of its branded drug, making it almost impossible for the generic companies to compete profitably, even though the branded drug's new price is barely covering its manufacturing and distribution expenses.

  How it illustrates the term: A price/cost analysis would be performed to determine if the pharmaceutical giant's new, lower price for its branded drug falls below its average variable cost (e.g., cost of active ingredients, packaging, direct labor for production) or average total cost. If the analysis reveals that the company is selling below these costs, it suggests an attempt to stifle generic competition and maintain its market dominance, which is a form of predatory pricing.

• Example 3: Online Retailer's Product Launch

  A major online retailer, known for its vast market reach, decides to enter a niche market previously served by several small, independent online shops (e.g., artisanal coffee beans). The large retailer launches its own line of coffee beans, pricing them at a level that is barely above its wholesale purchase cost and significantly below the prices offered by the smaller competitors, who have higher operational overheads.

  How it illustrates the term: A price/cost analysis would examine the online retailer's selling price for its coffee beans against its average variable cost (e.g., wholesale cost of beans, packaging, shipping costs per order) and average total cost (including a portion of its massive warehousing and marketing expenses). If the analysis shows that the retailer is selling at prices that are not sustainable for a typical business, especially if it's below its own costs, it could indicate an illegal strategy to drive the smaller, niche competitors out of business.