With increasing competition from other information media, to maintain market share newspapers are under constant pressures to reduce prices for advertising, which managers often discount for targeted customer groups. However, in doing so newspapers run the risk of being charged with predatory pricing by a competitor or a government anti-trust enforcement agency.
Predatory pricing involves selling a product below cost with the intent of monopolizing a market by under-pricing competitors. It is unlawful under the Sherman Act and under the unfair pricing acts of many states. To minimize their risk of being dragged into expensive litigation, newspaper managers should be aware of the price (or cost) test used by courts in predation cases. They should also know how to accurately analyze their product costs to discount fairly. Current available literature reflects a lot of confusion about how to fairly analyze product costs under the unique circumstances of the newspaper business.
It is widely recognized in the industry that there are two products associated with a newspaper, a circulation product (copies of the newspaper) and an advertising product (really a service of providing access to readers). The standard industry approach to costing these products is to equate the circulation product to the editorial content of the newspaper and the advertising product to the paper's advertising content. However, this approach does not differentiate one component of the products from the total product sold and so results in an incorrect cost allocation.
This issue of how to define the newspaper products was critical in a California lawsuit filed by a thrice-weekly free paper against a large paid daily paper.(1) To attract some classified ads from the smaller paper, the large daily reduced its price by approximately 40 percent. The daily paper justified this reduction by claiming that the cost of its advertising product is limited to the cost of producing its advertising space. However, the paper's senior managers testified that advertisers buy their service based on the editorial content's ability to attract readers. The Court ruled that the daily paper's cost analysis was inadmissible because none of the cost of the editorial content was allocated to advertisers.
Current test for predatory pricing
In general, charges of predatory pricing are based on Section 2 of the Sherman Act or individual state codes that prohibit a company from selling a product below cost with the intent to injure competitors.(2) Because the law refers to selling below "cost," it is usually up to the courts to decide how to determine this cost.
Many courts have relied on an average variable cost calculation to determine predatory pricing. In a 1987 Yale Law Review(3) article, economists Phillip Areeda and Donald Turner argued that in competitive markets, price usually equals the short run marginal cost (SRMC) or the cost a firm incurs for producing each additional unit in the short term. Since it is difficult if not impossible to determine a firm's short run marginal cost, Areeda and Turner recommended using average variable cost of producing units instead(4)
Other prominent economists have argued that the correct test of predatory pricing is whether goods are sold below long-run marginal cost with the intent to exclude an equally or more efficient competitor.(5) Since there are also problems in calculating a firm's long-run marginal cost, Richard Posner and other economists recommend using average total cost as a proxy. Because pricing below average total cost could represent a rational decision for a firm that is disinvesting or exiting the market, Posner argues that any definition of predatory pricing should combine a price test based on average total cost with other factors such as predatory intent.(6) Some courts, most prominently California, have adopted the Posner approach to analyzing predatory pricing.
Allocating cost in the newspaper industry
The nature of the newspaper business puts a unique twist to applying the different predatory pricing tests. To apply either price/cost test, newspaper managers must first allocate cost to the two products generally associated with the newspaper, namely the circulation product and the advertising product. The publisher is selling a service that allows advertisers to reach newspaper readers, and so could not sell advertising without producing a newspaper. On the other hand, the economics of the newspaper market make it necessary to sell advertising to sell newspapers. Without advertising, the price of the newspaper would be too high to attract many buyers.
The dual product/service nature of the newspaper business means that all costs are joint costs.(7) Production of the physical newspaper is a single process but the output serves different and separate markets. The key difference between newspapers and the classical joint cost examples in accounting textbooks is the absence of a split-off point where the outputs of the process become separately identifiable products, Copies of me paper sold to readers are the same physical instruments used to provide the services sold to advertisers.
Newspaper managers instinctively understand …