The opinion of the court was delivered by: Moran, District Judge.
This action, in which plaintiff Jays Foods (Jays) alleges that
it was a victim of predatory pricing, comes before this court ten
years after the seminal article by Professors Areeda and Turner
which outlined a cost-based definition of predatory pricing.
Areeda and Turner, Predatory Pricing and Related Practices Under
Section 2 of the Sherman Act, 88 Harv.L.Rev. 697 (1975).
Defendant Frito-Lay's (Frito-Lay) motion for summary judgment on
Count I requires this court to determine what fealty to give
cost-based tests of predatory pricing in light of a decade of
judicial responses to the article and its progeny. It also comes
in the wake of full and complete discovery. The question,
therefore, is whether there is sufficient evidence to create
Frito-Lay is a national producer of a full range of salty snack
foods such as potato chips and pretzels. Its competitors include
regional suppliers of a more limited range of snack foods. Jays
is one of these regional competitors. Its primary product is
potato chips and its market consists of parts of Illinois,
Wisconsin, Michigan and Indiana.
In an antitrust case plaintiff has the burden of establishing
the relevant product and geographic markets. See L.A. Draper &
Son v. Wheelabrator-Frye Co., 735 F.2d 414 (11th Cir. 1984).
While Jays' complaint covers several products and geographic
markets, for purposes of the motion for summary judgment the
relevant geographic market is the Chicago area and the relevant
product is potato chips. The summary judgment motion is further
focused on the sale of potato chips in supermarkets. Supermarket
sales account for over 60 per cent of the total sales of snack
foods. The Chicago market is presumably the center of Frito-Lay's
allegedly illegal competitive practices, and is the largest
market served by Jays.
Potato chip sale levels are related to the amount of
supermarket shelf space available to a supplier. Sales levels are
also related to promotional incentives given stores and their
customers. Sufficient shelf space is also required to introduce
new products. Stores allocate shelf space to suppliers on the
basis of the sales of each supplier's products.
There seems to be little doubt that in the day-to-day
commercial warfare between snack food suppliers the key battle is
over shelf space. Frito-Lay believed that the company with the
greatest share of potato chip business would control the entire
salty snack sections of the supermarkets. Because potato chip
sales were the core of the regional competitors' strength,
Frito-Lay especially sought to increase its market share of
potato chips. In its complaint Jays alleges that Frito-Lay
provided misleading and inaccurate market studies to major
retailer chains in order to increase its share of shelf space at
the expense of other competitors. Frito-Lay also allegedly
engaged in advertising and promotional practices which helped it
to secure additional shelf space. Finally, Frito-Lay allegedly
used its dominance in the corn chip market as leverage to induce
stores to provide additional shelf space for its other products.
During the 1974-1980 period which is the subject of this
lawsuit,*fn1 Jays was the larger of the two potato chip suppliers in
the Chicago area. During the same period Jays was apparently
attempting to expand into other salty food product lines and
become a supplier of a full range of snack products. Both
companies' sales grew during this period. In 1974 Frito-Lay's
Chicago division had total sales of $7,559,630 and showed a loss
of $35,329. By 1980 its sales had nearly doubled to $13,545,170
and its profits had reached $1,057,830. The record does not
contain figures for Jays' performance in the Chicago market.
Jays' total net sales grew from $22,970,172 in 1974 to
$44,352,969 in 1980. Jays' pretax profits rose from $139,749 in
1974 to $2,319,620 in 1977, before tapering off to $948,557 in
1980. The record does not indicate what shifts occurred in each
company's share of the Chicago potato chip market.*fn2
The record makes clear that Chicago was one of the "problem"
markets for Frito-Lay. Frito-Lay faced strong local competition
in potato chip sales and its performance lagged relative to other
markets. Consequently, Frito-Lay devoted extra promotional and
advertising resources to the Chicago market. These promotions
included substantial price discounts, some of which were
unauthorized, and a strong emphasis on potato chips in the
supermarket display shelves ("overfacing").
The record suggests that Frito-Lay set its prices with an eye
towards competitive conditions. A summary of Frito-Lay's pricing
objectives identified three approaches to pricing based on market
conditions. In high-growth product categories, where Frito-Lay
had market leadership, prices were to be set "most aggressively."
In low-growth categories, where Frito-Lay had shared market
leadership, prices were to be less aggressive. Finally, in
"low-growth categories where we do not dominate we will price
competitively (e.g. potato chips)."
What is also evident from the record is that Frito-Lay's guide
in setting prices was its corporate financial goals. Its pricing
decisions were "designed to maintain total corporate gross margin
at target level of 50%."
Jays' first amended complaint contains three counts. Count I
alleges that Frito-Lay has engaged in predatory pricing in
violation of Section 2 of the Sherman Act. Count II is brought
under Section 2 of the Clayton Act and alleges that Frito-Lay has
engaged in illegal price discrimination. Count III contains
pendent claims brought under the deceptive trade practices laws
of the states served by Jays and alleges that Frito-Lay engaged
in anti-competitive conduct. Jays claims that it sustained a loss
totalling $4,311,806.73 for fiscal years 1975-1981, because of
its inability to increase prices to reach a 6% pre-tax rate of
return as a result of Frito-Lay's anti-competitive conduct.
In Count I Jays claims that Frito-Lay attempted to monopolize
the Chicago market for potato chips in violation of Section 2 of
the Sherman Act. 15 U.S.C. § 2. The elements of an attempt to
monopolize are (1) intent to control prices or destroy
competition with respect to a part of commerce; (2) predatory or
anti-competitive conduct directed at accomplishing the unlawful
purpose; and (3) a dangerous probability of success. Chillicothe
Sand & Gravel Co. v. Martin Marietta Corp., 615 F.2d 427, 430
(7th Cir. 1980).
The parties agree on the definition of predatory pricing as the
dominant firm's deliberate sacrifice of current revenues through
lower prices for the purpose of driving rivals out of the market.
Once it has vanquished its rivals, the dominant firm can more
than recoup its short-term losses through higher profits earned
in the absence of competition. MCI Communications Corp. v.
American Telephone & Telegraph Co., 708 F.2d 1081, 1112 (7th
Cir.), cert. denied, ___ U.S. ___, 104 S.Ct. 234, 78 L.Ed.2d 226
(1983). The parties disagree on the proper test for predation,
namely, the sufficiency of cost-based measures of predation and
the relevance of non-cost indicia of predatory intent.
The modern era of predatory pricing analysis was ushered in by
Professors Areeda and Turner. Areeda & Turner, Predatory Pricing
and Related Practices Under Section 2 of the Sherman Act, 88
Harv.L.Rev. 697 (1975). They argued that prices at or above
marginal cost, even if not profit-maximizing, generally should be
presumed to be non-predatory. Id. at 711. Marginal cost is the
"increment to total cost that results from producing an
additional increment of output." Because marginal costs are
difficult to determine, Areeda and Turner advanced average
variable cost as an acceptable surrogate for marginal cost. Id.
at 716-718. Variable costs are costs which vary in a short run
with changes in output. Such costs include items such as
materials, labor, fuel, use depreciation, and a return on
investment needed to attract enough working capital to pay for
variable costs. Average variable cost is total variable cost
divided by output. Fixed costs, in contrast, are costs which in
the short run do not vary with changes in output. Fixed costs
include such items as management expenses, interest on bonded
debts and other items of irreducible overhead. Total cost is the
sum of fixed and variable costs and average total cost is the
total cost divided by output. See generally Northeastern
Telephone Co. v. American Telephone & Telegraph Co., 651 F.2d 76
(2d Cir. 1981).
The Areeda & Turner formula has won wide if cautious acceptance
by the courts. Some courts have hewed closely to average variable
cost as the conclusive test of predatory pricing. See e.g. Barry
Wright Corp. v. ITT Grinnell Corp., 724 F.2d 227 (1st Cir. 1983);
Northeastern Telephone, supra. Most courts have recognized the
central importance of a cost-based test of predatory pricing, but
have noted that in unusual circumstances special market
characteristics, such as high entry barriers, might permit a
finding of predatory pricing even if prices were above average
cost but below average total cost. See e.g. Chillicothe Sand &
Gravel, 615 F.2d at 431-32; Pacific Engineering & Production Co.
v. Kerr McGee Corp., 551 F.2d 790, 797 (10th Cir.), cert. denied,
434 U.S. 879, 98 S.Ct. 234, 54 L.Ed.2d 160 (1977); International
Air Industries, Inc. v. American Excelsior Co., 517 F.2d 714,
723-25 (5th Cir. 1975), cert. denied, 424 U.S. 943, 96 S.Ct.
1411, 47 L.Ed.2d 349 (1976). The Ninth Circuit has strayed most
from sole reliance on a cost-based test of predation. See
Transamerica Computer Co., Inc. v. IBM Corp., 698 F.2d 1377 (9th
Cir. 1983). See also D.E. Rogers Associates, Inc. v.
Gardner-Denver Co., 718 F.2d 1431 (6th Cir. 1983), cert. denied
___ U.S. ___, 104 S.Ct. 3513, 82 L.Ed.2d 822 (1984). In
Transamerica the court held that by reference to non-cost factors
a plaintiff could show that a defendant engaged in predatory
pricing even if its prices were above average total cost. Id. at
In Chillicothe Sand & Gravel the Seventh Circuit recognized the
centrality of the average variable cost test in the analysis of
a predatory pricing claim. It cautioned, however, that non-cost
factors were not to be neglected when determining whether a
defendant's pricing policy was predatory:
[W]hile we accept the use of marginal or average
variable cost as both a relevant and an extremely
useful factor in determining the presence of
predatory conduct we are willing to consider the
presence of other factors in our evaluation of
whether or not plaintiff has made out a prima facie
case of monopolizing or attempt to monopolize.
615 F.2d at 432. Indeed, after concluding that defendant's prices
were above average variable cost, the Chillicothe court went on
to consider and ultimately to reject a variety of non-cost
factors which plaintiff had argued revealed defendant's predatory
intent. Id. at 432-34.
In MCI Communications Corp. v. American Telephone & Telegraph
Co., 708 F.2d 1081 (7th Cir.), cert. denied, ___ U.S. ___, 104
S.Ct. 234, 78 L.Ed.2d 226 (1983), the Seventh Circuit confronted
allegations that AT & T had engaged in predatory pricing of two
of its services for long distance business communications. MCI,
708 F.2d at 1111. The issue at MCI was not the validity of the
Areeda and Turner average variable cost test; neither party ever
argued for application of a short run cost standard. 708 F.2d at
1115. While MCI noted some of the shortcomings of the average
variable cost test, id. at 1115-16, the decision cannot be read
as a repudiation of that test. In fact, the court expressly
stated that "pricing below average variable cost is normally one
of the most relevant indications of predatory pricing." Id. at
1120, n. 55.
Perhaps the strongest and most repeated criticism of the
average variable cost test of predatory pricing is its focus on
short term rather than long term costs. See e.g. Scherer,
Predatory Pricing and the Sherman Act: A Comment, 89 Harv.L.Rev.
869, 890 (1976). Then Professor Posner, for example, recognized
the usefulness of the Areeda and Turner average variable cost
formula, but concluded that predatory pricing also exists when a
company sells its product below its long-run marginal cost with
the intent to exclude a competitor. R. Posner, Antitrust Law, at
189. Long-run marginal costs are costs that must be recovered in
order for a business to survive into the indefinite future. Id.
Because all costs are variable in the long run, long-run marginal
costs include both the fixed and variable components of
In MCI the court adopted the long-run incremental cost of
providing the two long distance services as the standard by which
to determine if AT & T's prices were predatory. The long-run
incremental cost of producing a product is total company cost
minus what the total cost of the company would be in the absence
of manufacturing the product, divided by the quantity of product
being manufactured. See Baumol, Quasi-Permanence of Price
Reductions: A Policy for Prevention of Predatory Pricing, 89 Yale
L.J. 1, 9, n. 26 (1979). Long-run incremental cost includes fixed
as well as variable cost of both capital and operating items.
Unlike measures of fully distributed cost, long-run incremental
cost is calculated with reference to current and anticipated
cost, rather than historical or imbedded cost. MCI, 708 F.2d at
1116-18. The long-run incremental cost test, in short, measures
the costs caused by the production of a product. Id. at 1116.
Other courts have been slow to adopt the long-run incremental
MCI is also important for its discussion of the role of
non-cost factors in the analysis of predatory pricing. The
court's most complete statement on the issue was:
We do not intend to imply that in all cases and in
all circumstances we would only examine the
price-cost relationship of a product or service. Our
test merely suggests that a judge and jury may not
infer predatory intent unless price is below long-run
incremental cost. . . . [However,] a strong
presumption of lawfulness must attach when price is