Amelia Fletcher

Office of Fair Trading

You will not find many, if any, of the economic consultancies in this handbook guaranteeing to match the lowest fees you can find in the market. Nor are such guarantees often offered by the competition lawyers they work with. Such promises are not a great marketing ploy in markets, such as these, where purchasers suspect there to be a link between quality and price, and strongly value quality.

When a retailer, however, claims to have the lowest prices on the market, consumers are more easily impressed. They can, they feel, be sure of getting a great price by going to the retailer in question - without any need to engage in pesky shopping around. And if they are getting pretty much the same, or even an identical, product, then who cares about quality?

Such deals can provide a great way for a retailer to signal that it is low cost and has low prices. Equally such deals are sometimes used by more upmarket stores to signal that their added service and higher quality retail environment do not come at the cost of higher prices.

For a long time, competition authorities have been fairly sanguine about deals like this, in line with the positive feelings of the typical consumer. This relaxed view has no doubt been appropriate in many cases. But are deals of this sort always as good as they sound?

The most obvious concern one might have about them is that they might be knowingly untrue. As such, consumers could be being conned into paying more than they would if they shopped around. This is a concern that might properly be addressed using consumer law rather than competition law.

Another set of concerns, though, relate to the possible implications of 'lowest price' promises for competition. These can arise for a number of possible reasons.

In many cases these promises are accompanied by a 'price match guarantee' - if you can find it cheaper elsewhere, then the retailer will match that price (or even reduce the price by 'double the difference'). A first area of possible competition concern is that, while such price match guarantees appear to support the 'lowest price' claim, they can equally be used as a way to price discriminate. The 'lowest prices' are made available to those buyers who are willing to face the hassle of seeking out alternative prices in order to utilise the price match guarantee, but base prices are kept somewhat higher for those buyers who do not shop around.

Such price discrimination can potentially have benefits, especially if it expands the market. But it can also have costs, for example in terms of denying the benefits of competition from those buyers who do not shop around.

Moreover, there is a risk that the existence of the 'lowest price' promise itself limits shopping around. Consumers who feel protected by the 'lowest price' promise, and the back-up price match guarantee, may not bother shopping around as much as they would otherwise. This raises a second area of potential competition concern, since less shopping around will tend to imply a softening of competition. After all, the strength of the competitive constraint faced by any firm will generally depend on the extent to which consumers test its offering against those of its rivals before purchase.

A third area of possible competition concern arises from the impact such price match guarantees can have on the pricing incentives of rivals. If the rivals of a 'lowest price' retailer know that any price reduction will quickly be matched, then this reduces their incentive to reduce prices. Firms that cut prices are normally seeking to win extra sales from rivals who have not cut prices. If a firm knows that said rivals will follow its prices down immediately, and that consumers expect this, then it will expect to win far less (if any) extra business, and will therefore be much less likely to make the price cut at all.

This reduced incentive to cut prices can in turn imply less vigorous competition, and potentially higher prices than would be observed without the price match guarantee.

A fourth area of possible competition concern arises from the fact that price match guarantees of this sort can potentially act to facilitate collusion. Effective collusion between firms in a market is well known to require some sort of agreement (tacit or explicit) on a collusive strategy, as well the ability to detect breaches of this agreement. Reciprocal price matching strategies adopted by competing firms can provide a straightforward focal point for coordination and deviation can be very easy to detect - your customers come and tell you!

At an extreme, such price match strategies can potentially even relate explicitly the prices of the specific retailers involved in the collusion. That is, retailer A can promise to match retailer B's low prices, and retailer B can promise to match retailer A's low prices.

The available literature in this area suggests that such strategies may not enable rivals to achieve full coordination (that is, monopoly pricing) because the punishments implicit in price matching guarantees are relatively small. However, such guarantees can nevertheless sustain more limited collusive outcomes, and they can do this in a relatively wide set of real world situations.

A fifth, and final, area of competition concern around price matching guarantees arises from the fact that they can potentially act to foreclose entry. A large incumbent firm in a market will often have a number of intrinsic advantages over a potential entrant, most typically based on their established reputation and established customer base. A standard strategy for new entrants into such a market is to seek to gain a foothold by offering better prices than the incumbent.

Clearly, in such a context, a price match guarantee by the incumbent firm can be a very powerful way of demotivating entry. A potential entrant may well be deterred from entering on the basis of low prices if it knows those prices will be immediately replicated by the incumbent firm. And of course if the entry never occurs, the incumbent firm never actually has to make the price cuts. It can retain its 'lowest price' promise while continuing to retain a strong market position and prices that are in fact relatively high.

An issue that often arises in assessing the validity of foreclosure stories such as this is whether the incumbent firm's threat (in this case to match the low prices of any entrant) is really credible. Surely it would, in practice, have an incentive to maintain its prices and accommodate a small amount of entry? The interesting thing about a price match guarantee in this context is that its public nature can in itself make it credible. Having made a public guarantee, potentially even making it legally enforceable under contract or consumer law, the incumbent firm will be far more likely to stick to the strategy, if only to preserve its reputation, than it would have been to stick to an unannounced version of the same strategy.

So does this imply that competition authorities should take a stronger line on such 'lowest price' promises and price match guarantees? Certainly it suggests that taking a totally sanguine view towards them may be misguided. However, given that such guarantees can offer benefits, especially when offered by relatively small players in relatively fragmented markets, it would equally not be appropriate to consider them all inherently anti-competitive. Instead, there would seem to be merit in considering further the circumstances in which such guarantees are more, and less, likely to harm competition.

In doing so, it is worth highlighting that the price match guarantees discussed so far in this paper are made unilaterally by sellers to buyers, and are not typically embedded in formal agreements. These are, though, just one form of a wider class of arrangements, which one might term 'across-seller price relationship arrangements'.

Another variant of such agreements, which is considerably more likely to harm competition, is where the price matching is embedded in formal contracts in the supply chain. These contracts could potentially be between the sellers themselves, in which case they would amount to a horizontal price fixing arrangement. However, and perhaps more likely, they can also be embedded in agreements with a shared downstream distributor or upstream supplier. For example, suppose that supplier A incorporates a 'lowest retail price clause' into its sales agreement with retailers, requiring the retailer to price its products no higher than, or even at the same price as, the prices of any products that it sells from rival suppliers. Now suppose that its rivals in the market, suppliers B and C, also have requirements of the same form.

It is clear that such a set of 'lowest price clauses' will have the effect of requiring any retailer to set identical prices across the different suppliers' products. But what is the potential impact on competition?

It is not difficult to assess the likely effect on the competitive incentives of the three suppliers in this example. In a standard competitive setting, a key motivation for suppliers to cut their wholesale prices to retailers is that these will be passed on as lower relative retail prices and that the supplier will thereby win sales from its rivals. By removing any potential for changes in wholesale prices to feed into changes in relative retail prices, such 'lowest price clauses' in fact reduce very considerably the incentives of any supplier to cut its wholesale prices. Moreover, while the resulting harm to competition is greatest in a case where all suppliers in the market have these clauses, competition will also be restricted where just one supplier has such a clause.

Such clauses could also inhibit new entry in just the same way as described above. A low cost new supplier can offer as low a wholesale price as it wants, and retailers will still not sell it at a retail price any lower than the incumbent suppliers. It is noteworthy, too, that because such price matching is not public, the efficiency benefits discussed above - of signalling low prices - will not exist here.

All of this adds up to a view that the authorities should be taking a stronger stance against contractual provisions of this type than against the simple unilateral price match guarantees described earlier.

Finally, this short article has focused on price matching arrangements which link the prices charged by competitors in a market. There is, however, a second class of price matching arrangements which link the prices charged by an individual supplier to its various customers. These can be termed 'across-buyer price relationship arrangements.' A good example are so-called 'most favoured nation' or MFN clauses which commit a supplier giving a particular customer the lowest price that it offers to any other customer.

Such agreements are often requested by buyers, keen to ensure that they have a competitive input price. However, they can potentially raise some of the same concerns as set out above, and in practice can thereby have the effect of raising input prices to buyers to above competitive levels. MFNs have been the subject of past antitrust activity, and indeed are the subject of the ongoing US Department of Justice case against Blue Cross Blue Shield of Michigan. However, MFNs would properly justify a separate article and are not therefore covered here.

Further discussion of price relationship agreements, of the types described in this article, can be found in forthcoming economic research report on this topic, commissioned by UK Office of Fair Trading from Lear (Laboratorio di Economia, Antitrust, Regolamentazione).

About the author

Amelia Fletcher joined the OFT in 2001. She previously worked as an economic consultant, focusing on antitrust cases, for Frontier Economics and prior to that London Economics.

During her time at the OFT, Amelia has worked across most areas of the OFT's work. She has been involved in developing economic thinking on competition policy, market studies and, more recently, consumer policy. She has overseen an innovative and influential series of OFT economic research papers, and played a key role in instigating the OFT's evaluation and competition advocacy programmes, both of which are now well established. Since 2009, she has also been an OFT decision maker on mergers, alongside her role as chief economist.