A new paper suggests that Amazon’s negative cash flow rapid expansion story may in fact conceal a long-term predatory pricing strategy that violates existing antitrust laws.
In January of this year, Amazon briefly became the world’s most valuable public company (It has since lost that title to Apple). Achieving this milestone marked a high-water point in the firm’s meteoric rise. But perhaps even more noteworthy is the fact that Amazon attained this venerated position without turning in any significant profit.
In fact, if a careful observer overlooks the GAAP loopholes that allow Amazon to dress up its numbers, during 2017 the firm experienced a negative cash flow of $1.461 billion, with its lease repayments alone totaling $200 million. Moreover, as of 2018, those lease obligations were only part of an enormous amount of debt—upwards of $50 billion—that Amazon owed its creditors. Far from a temporary dip, 2017 represents the norm for the company: Amazon has operated with a negative cash flow for the majority of its existence.
Amazon has justified not turning a profit to its investors by stating that such profit sharing would diminish its ability to leverage raised capital to enable rapid expansion and substantial internal investment. The strategy reflected in these statements is that Amazon is increasing its present fixed costs to facilitate the future expansion of its overall productivity and overall revenue. In other words, the long-term goal of Amazon appears to be to facilitate a time in the future in which the company would become hugely profitable.
In the past year, Amazon’s corporate conduct came under scrutiny from multiple sources across the political spectrum. Additionally, new voices within the legal academic world, most notably Lina Khan, suggested that antitrust laws should be revised in order to better check Amazon’s increasingly recognized power. Most recently, an uproar broke out following the revelation that Amazon has begun raising prices at Whole Foods, after initially slashing them following its acquisition of the chain. Such activities, albeit legal, further exacerbated the outcry of Amazon’s critics, who already chastised the firm’s long-term growth strategy.
In a forthcoming paper, “Prime Predator: Amazon and the Rational of Below Average Variable Cost Pricing Strategies Among Negative-Cash Flow Firms,” I suggest that Amazon’s negative cash flow rapid expansion story may in fact conceal a more nefarious growth strategy that violates existing antitrust laws. The paper presents a theoretical explanation of how Amazon’s past and current conduct might be in violation of existing antitrust laws, namely Section 2 of the Sherman Antitrust Act. Simply put, I argue that instead of making legitimate investments which increase its fixed costs, Amazon might be engaging in a long-term predatory pricing strategy.
What Constitutes a Predatory Pricing Strategy?
In 1975, Phillip Areeda and Donald Turner published their groundbreaking work on anticompetitive pricing strategies, “Predatory Pricing and Related Practices under Section 2 of the Sherman Act.” That article, published in the Harvard Law Review, set forth a straightforward test to determine whether a given firm’s pricing strategy was in violation of the law.
According to Areeda and Turner, a firm that engages in predatory pricing is a firm whose pricing strategy seeks to drive out or exclude rivals by selling its products at an unprofitable or unremunerative price. Under the test proposed by the two, a plaintiff must first demonstrate that the market in which the alleged predator operates is favorable for predation and that such a pricing strategy is rational. He must then proceed to establish that the alleged predator’s prices are either below the firm’s average variable costs (AVC) or its marginal costs (in certain scenarios).
According to the two, such an act of predation was rational if the firm which had lowered its prices in Time 1 (during predation) was able to recoup its loses in Time 2 “through higher profits earned in the absence of competition.”
In 1978, Robert Bork published The Antitrust Paradox, his seminal work in the field of antitrust. As a proponent of the Chicago School, Bork naturally drew rather extensively upon the contributions of Areeda and Turner and incorporated their theory of predatory pricing into his work. However, in Bork’s account, the definition of recoupment was subtly—yet nonetheless crucially—revised. Instead of simply defining recoupment as earning higher profits in the absence of competition, Bork held that recoupment can only occur through a rise in prices.
As mentioned, this change might seem trivial or minor, but its ramifications were significant. In subsequent decades, the Supreme Court came to adopt the price predation test as it was formulated by Bork, and Circuit Judge Frank H. Easterbrook came to view this pricing strategy as irrational and unlikely. In short, by the turn of the century, Areeda and Turner’s groundbreaking theory was rendered moot by the courts.
I argue that the original definition of term recoupment, as it was first suggested by Areeda and Turner, should be significantly broadened. I seek to demonstrate that recoupment could be achieved without a rise in prices in the post-predation period and that higher profits could be attained in the absence of competition by other means. In particular, I seek to show that higher profits could be the result of capturing a greater market share and/or the development of technological efficiencies.
For example, a peer-to-peer ride sharing firm that relies heavily upon its drivers could price its services today to reflect its future projected costs once it transitions to fully electric autonomous cars. In this example, the firm’s current average variable cost (AVC) would most certainly exceed the prices it charges consumers. Normally, such a strategy would be considered irrational. But this predation strategy is entirely rational if the firm could recoup this loss by lowering its AVC costs below the price paid by consumers at some time in the future.
The Sherman Act was passed in 1890, prior to the emergence of the Progressive movement or today’s federal regulatory agencies. It was championed by populist thinkers who distrusted regulation and dreaded regulatory capture. For that reason, the framers of the Sherman Act insisted that it would contain a provision that allowed private actors, namely injured competitors, to bring a private cause of action in order discipline firms that appeared to act in an uncompetitive manner.
Additionally, the Sherman Act itself contains broad, almost deliberately vague language. It was passed prior to the Supreme Court’s adoption of the Erie doctrine, which imposed a prohibition on the application of the Court’s historically extensive commercial law jurisprudence. The Act’s framers therefore envisioned the development of robust antitrust common law doctrines that would continually develop in response to new and increasingly sophisticated legal arguments fashioned by savvy plaintiffs and defendants.
In light of this history, the work of Areeda and Turner in the field of anticompetitive pricing should be viewed as an important contribution to the common law doctrine of antitrust. My paper’s effort to revitalize their work should be viewed as an attempt to encourage private plaintiffs to bring forward legal action against competitors that appear to act in violation of the law.
Predators Are Notoriously Hard to Detect
I chose Amazon as a case study simply because it was among the first—and most certainly the biggest—negative cash flow firms. Predators, like the alien in the classic 1987 movie of the same name, are notoriously hard to detect. The paper does not assert that Amazon is a price predator, but rather that it should be viewed a prime suspect. I suggest that due to existing rules governing the disclosure of costs, Amazon might be concealing short-, medium- or long-term periods in which it engages in price predation. In theory at least, such corporate behavior is both rational and lucrative. As explained above (and in a more extensive manner in the paper), these activities are rational when the costs of current below AVC predation are expected to be recouped in the future by achieving a significant reduction in Amazon’s AVC.
The paper attempts to offer the analytical tools to bring a private cause of action against firms such as Amazon that would survive a motion to dismiss. As explained above, to survive the pleading stage, a plaintiff need only claim that it is objectively rational for the alleged predator to engage in predation and that his current overall prices are below the firm’s estimated AVC. Of course, it is entirely possible that during the discovery phase of litigation it would be revealed that the accused firm did not engage in anticompetitive activities, but the threat of successful litigation itself might discipline other firms that consider dabbling in this anticompetitive practice.
Finally, it is crucial to remember that Areeda and Turner firmly believed that antitrust laws, including the prohibition against price predation, should primarily benefit consumers and the paper does not suggest any shift in that respect. But we must not conflate the focus on consumer welfare with a general aversion to private causes of action that are brought by injured competitors. The beauty of the Sherman Act lies in the fact that by promoting their own self-interest, injured firms contribute to the preservation of a more robustly competitive market that in turn benefits us, the consumers.
Shaoul Sussman is a third-year law student at Fordham University School of Law and legal intern at Pearl Cohen Zedek Latzer Baratz LLP. His paper, “Prime Predator: Amazon and the Rational of Below Average Variable Cost Pricing Strategies Among Negative-Cash Flow Firms,” will be published this month in Oxford’s Journal of Antitrust Enforcement.
For further discussion of Amazon and antitrust law, listen to the following episode of the Capitalisn’t podcast:
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