FTC Staff Comment to the Honorable Eliot Spitzer Concerning the New York Motor Fuel Marketing Practices Act

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July 24, 2003
The Honorable Eliot Spitzer
Attorney General
120 Broadway
New York, New York 10271-0332
Dear General Spitzer:
The staffs of the Federal Trade Commission’s Office of Policy Planning and
Bureau of Competition are pleased to respond to your request, sent to us on July 1, 2003
by Assistant Attorney General Richard Grimm, for comments on New York’s Motor Fuel
Marketing Practices Act (“MFMPA”), Bill Nos. A.8398 and S.4947. 1 The MFMPA
would prohibit refiners and nonrefiners of motor fuel from selling motor fuels below 98%
of the bill’s definition of refiner and nonrefiner cost, respectively, where the effect is to
injure competition.
We believe that there is a significant risk that the MFMPA could harm consumers.
Last August, FTC staff submitted comments to Governor Pataki on a virtually identical
bill, S.4522-B, which the governor ultimately vetoed. In those comments (copy
attached), FTC staff concluded that the bill was at best unnecessary and at worst could
discourage pro-competitive pricing. The current bill suffers from the same flaws. The
changes – banning sales below 98% of cost, rather than cost, and creating a de minimis
exception – do not correct the fundamental problems in the previous bill. In particular,
the 98% measure appears arbitrary, with no basis in Supreme Court precedent, federal
antitrust law, basic economic theory, or empirical studies. Moreover, the de minimis
exception, while better than no exception at all, still appears too narrow to allow vigorous
competition.
Our views on the entire bill are summarized below:
• 	Low prices benefit consumers. Consumers are harmed only if, because of low
prices, a dominant competitor is able later to raise prices to supracompetitive
levels. See Attached Letter at 6-7.
1 This letter expresses the views of the Federal Trade Commission’s Bureau of Competition and Office of
Policy Planning. The letter does not necessarily represent the views of the Commission or of any
individual Commissioner. The Commission has, however, voted to authorize us to submit these comments.
UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON, D.C. 20580

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• 	Economic and legal studies and court decisions indicate that below-cost pricing
that leads to monopoly rarely occurs. Below-cost sales of motor fuel that lead to
monopoly are especially unlikely. See Attached Letter at 8-11.
• 	The federal antitrust laws deal specifically with below-cost pricing that has a
dangerous probability of leading to monopoly. The FTC, the Department of
Justice’s Antitrust Division, state attorneys general, and private parties can bring
suit under the federal antitrust laws in response to anticompetitive below-cost
pricing. See Attached Letter at 5-6.
• 	When there is no danger that a monopoly might later be created, consumers are
harmed by public policies that have the effect of increasing low prices that are the
product of the competitive process. See Attached Letter at 7-8.
• 	The MFMPA has the potential to discourage pro-competitive price reductions.
Under the bill’s definition of “competition,” a supplier likely could face antitrust
liability for pricing below a single competitor, even if consumers benefit from the
lower prices and even if there is no risk that the supplier could recoup its lost
profits. Moreover, the 98% of cost measure appears arbitrary, while the
MFMPA’s de minimis exception appears too narrow to allow vigorous
competition.
Analysis of the MFMPA
The MFMPA bans fuel sales below 98% of the nonrefiner or refiner “cost,” where
the effect is to injure “competition.” The Act defines “competition” as “the vying for
motor fuel sales between any two or more sellers in the same relevant geographic
market.” The Act defines “Refiner Cost” as the refiner’s posted terminal price of motor
fuel adjusted for several factors, including taxes, freight charges, direct labor costs, and
imputed rental value of the refiner’s retail outlet. It defines “Nonrefiner Cost” as the
invoice cost of motor fuel, adjusted for the same factors.
A. 	The MFMPA’s definition of competition
As the Supreme Court has recognized, federal antitrust laws are designed “for the
protection of competition, not competitors.”2 The federal antitrust laws recognize that
price-cutting benefits consumers and competition, because it forces producers to
minimize costs and prices, and to increase quality. Vigorous price competition promotes
consumer welfare, because consumers reap the benefits of lower prices, increased
productivity, greater variety, and higher quality goods and services. Accordingly, low
prices, and even below-cost prices, do not harm consumers unless sustained above-cost
prices can occur later on:
2 Brunswick Corp. v. Pueblo Bowl-O-Mat, Inc., 429 U.S. 477, 488 (1977) (quoting Brown Shoe Co. v.
United States, 370 U.S. 294, 320 (1962)).

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[T]he short-run loss is definite, but the long-run gain depends on successfully
neutralizing the competition. Moreover, it is not enough simply to achieve
monopoly power, as monopoly pricing may breed quick entry by new competitors
eager to share in the excess profits. The success of any predatory scheme depends
on maintaining monopoly power for long enough both to recoup the predator’s
losses and to harvest some additional gain.3
Therefore, even if a below-cost pricing strategy succeeds in temporarily reducing
the number of competitors, the price-cutter must find a way to keep competitors from
returning after it tries to raise prices again. Otherwise, the below-cost pricing strategy,
which requires that the firm incur losses on every sale, will not succeed. When a firm
fails to recoup short-run losses (from sales at below-cost prices) in the long run,
consumers enjoy a windfall, and without harm to consumers, an antitrust violation does
not occur. Along these lines, the Supreme Court has stated that “[t]he second prerequisite
to holding a competitor liable under the [federal] antitrust laws for charging low prices is
a demonstration that the competitor had a reasonable prospect, or, under § 2 of the
Sherman Act, a dangerous probability, of recouping its investment in below-cost
prices. . . .Evidence of below-cost pricing is not alone sufficient to permit an inference of
probable recoupment and injury to competition. . . .Although unsuccessful predatory
pricing may encourage some inefficient substitution toward the product being sold at less
than its cost, unsuccessful predation is in general a boon to consumers. . . .That below-
cost pricing may impose painful losses on its target is of no moment to the antitrust laws
if competition is not injured.”4
Like the previous bill, however, the MFMPA defines “competition” in a way that
likely would focus on protecting competitors, not consumers and competition. The bill
defines “competition” as “the vying for motor fuel sales between any two or more sellers
in the same relevant geographic market.” In other states, courts have interpreted similar
definitions of harm to competition to include harm to a single competitor.5 As Governor
Pataki stated, because of this “significant flaw,” a below-cost sale as defined by the
MFMPA “could constitute a violation so long as the effect was to ‘injure’ even a single
competitor.”6 As a result, the MFMPA is likely to discourage pro-competitive price-
cutting, which in turn could ultimately harm consumers by increasing the prices they pay
at the pump for gasoline.
B. 	The MFMPA’s arbitrary 98% of “cost” measure
In addition to defining “competition” in a way that does not protect competition
or consumers, the MFMPA defines “cost” in a way that is inconsistent with most antitrust
precedent and economic and legal literature. The Supreme Court has defined predatory
pricing as “pricing below an appropriate measure of [the defendant’s] cost for the
3 Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 589 (1986).
4 Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 224, 226 (1993).
5 See, e.g., McGuire Oil Co. v. Mapco, Inc., 612 So. 2d 417 (Ala. 1992); Racetrac Petroleum, Inc. v. Delco
Oil, Inc., 721 So. 2d 376 (Fla. App. 1998).
6 See Veto letter at 1 (copy attached).

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purpose of eliminating competitors in the short run and reducing competition in the long
run.”7 Although the Court has not stated what the appropriate measure of cost should be,
prominent antitrust scholars and several federal circuit courts have concluded that the
price-cutter’s marginal costs, or a close proxy such as average variable costs, should be
the yardstick. Many authorities conclude that average variable cost is the best yardstick,
for two reasons. First, a price at or above average variable cost is highly unlikely to drive
efficient competitors from the market. Once a firm has invested in fixed assets (such as a
service station), it is economically rational for the firm to continue operating as long as it
can cover its variable costs, even if prevailing prices sometimes fall below average total
cost. Second, a firm can price at average variable cost due to a wide variety of market
circumstances; penalizing a firm for doing so would therefore penalize pro-competitive
price cutting.8
The MFMPA, however, defines refiner and nonrefiner “cost” to include costs
other than average variable costs, including factors such as “direct labor costs” and the
imputed rental value of the retail outlet.9 By including these factors, the MFMPA (like
the previous bill) defines “cost” in a way that is higher than economically sensible, which
could have the effect of deterring pro-competitive price-cutting. Although the bill tries to
separate “direct labor costs” attributable to motor fuel sales from other sales, and thereby
to approximate average variable costs for motor fuel sales, as a practical matter, this
figure would be very difficult (and expensive) for retailers to calculate. For these
reasons, the MFMPA’s definition of cost would deter pro-competitive price-cutting.
Finally, the MFMPA’s use of a 98% measure appears completely arbitrary. FTC
staff could locate no support for the 98% measure from any authority on competition
policy, including Supreme Court precedent, federal antitrust law, basic economic theory,
or empirical studies. Nothing suggests that the 98% measure would benefit consumers or
promote competition. Moreover, that measure does nothing to address the MFMPA’s
more fundamental problem, which is that it defines cost inappropriately.
7 Cargill, Inc. v. Monfort of Colorado, Inc., 479 U.S. 104, 117 (1986).
8 See Kelco Disposal, Inc. v. Browning-Ferris Indus., 845 F.2d 404, 407 (2d Cir. 1988), aff’d on other
grounds, 492 U.S. 257 (1989) (finding that “[p]rices that are below reasonably anticipated marginal cost,
and its surrogate, reasonably anticipated average variable cost . . . are presumed predatory”); International
Air Indus. v. American Excelsior Co., 517 F.2d 714, 724 (5th Cir. 1975) (holding that plaintiff must show
that “either (1) a competitor is charging a price below his average variable cost ... or (2) the competitor is
charging a price below its short-run, profit maximizing price and barriers to entry are great enough to
enable the discriminator to reap the benefits of predation before new entry is possible”); P. Areeda and H.
Hovenkamp, Antitrust Law, ¶ 724; P. Areeda and D. Turner, “Predatory Pricing and Related Practices
under Section 2 of the Sherman Act,” 88 Harv. L. Rev. 697 (1975). In Brooke Group, the parties both
agreed that average variable cost should be the appropriate measure. See Brooke Group, 509 U.S. at 222
n.1.
9 Labor costs can be considered variable if the number of hours worked varies with the level of sales. For
large changes in sales this may occur, but for small changes it is unlikely that labor costs will vary with the
level of sales. In addition, the legislation specifies that the labor cost included in the cost calculation must
at a minimum include the cost of one full-time employee, which effectively treats at least a portion of labor
costs as fixed costs.

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C. 	The MFMPA’s de minimis exception
The second principal difference between the MFMPA and S.4522-B is the
creation of a de minimis “exception.” The bill would grant authority to the state
consumer protection board to dismiss complaints that, in the board’s view, result from a
de minimis injury to competition. As a practical matter, however, the exception likely
would not encourage pro-competitive price cutting, and instead likely would simply
increase uncertainty about the scope of the bill’s “below-cost” sales ban. This
uncertainty, in turn, could lead to higher prices for consumers. The bill provides no
guidance to the consumer protection board or to suppliers about how to evaluate de
minimis injuries. There is no information about how much of an injury, in terms of dollar
amount or percentage of sales, should be considered de minimis, nor is there any
information on whether an injury to a single competitor should be considered de minimis
(the bill’s text suggests that injury to one competitor would constitute a violation of the
MFMPA, even if there are dozens of competitors in the relevant geographic market). The
MFMPA’s narrow, ambiguously defined de minimis exception would not encourage
vigorous competition. Accordingly, it does not alleviate the significant risk that the bill
could harm consumers.
Conclusion
For these reasons, and the reasons outlined in the attached letter, FTC staff
concludes that this version of the MFMPA, like its predecessor, is more likely to harm
than to promote competition.
Sincerely,
Todd J. Zywicki
Director
Office of Policy Planning
Joseph J. Simons
Director
Bureau of Competition