Professional Documents
Culture Documents
VOL.4 NO.3
Spring
2003
and Predatory Pricing:
The Case of the
Petroleum Retail
Industry
BY THOMAS L. BARTON AND JOHN B. MACARTHUR
ABC ANALYSIS HELPED SETTLE A LAWSUIT AGAINST A GASOLINE RETAILER, PROVING THE
EXECUTIVE SUMMARY: The assignment of indirect costs in a traditional costing system can lead to product-cost
subsidization. This is where excessive costs are charged to high-volume products and insufficient costs are
charged to low-volume products. The result can lead to increased consumer demand for the undercostedand
underpricedproducts and reduced customer demand for the overcostedand thus overpricedhigh-volume
product. One way to deal with this problem is to employ activity-based costing (ABC). Product-cost subsidiza-
tion also may have legal consequences, which ABC can help address. Undercosted products can lead to the
appearance of predatory pricing where it actually does not exist. This article focuses on a lawsuit brought against
a major chain of retail motor fuel (gasoline) service centers for allegedly selling regular-grade gasoline below
cost, as defined by state statutes. The defendant employed ABC analysis to support its position that it was not
selling its regular gasoline below cost. After the ABC analysis was presented, the case was settled, and the judge
lifted the initial injunction.
Activity-based costing (ABC) was originally developed insufficient costs being charged to low-volume prod-
by companies to deal with the problem of product-cost ucts. The result can lead to increased consumer
subsidization in traditional costing systems.1 This is demand for the undercostedand underpriced
where the assignment of indirect costs leads to exces- products and reduced customer demand for the over-
sive costs being charged to high-volume products and costedand thus overpricedhigh-volume product.2
A. Unit-Based Approach:
ACTIVITY
FACILITY-WIDE COST TOTAL DRIVER REGULAR PLUS PREMIUM
Average Monthly Cost $26,300 Gas Sold2 $16,674 $5,129 $4,497
Cost Per Gallon Sold $ 0.058 $0.058 $0.058
C. ABC Approach:
ACTIVITY
ACTIVITY COST POOLS TOTAL DRIVER REGULAR PLUS PREMIUM
Pool 1-Labor $ 9,300 Gas Sold2 $ 5,896 $1,814 $1,590
Pool 2-Kiosk $ 2,737 Gas Sold2 $ 1,735 $0.534 468
Pool 3-Gas Dispensing $14,263 1/3 each $ 4,754 $ 4,754 $ 4,755
Total Cost $26,300 $12,385 $7,102 $6,813
Cost Per Gallon Sold $ 0.043 $0.080 $0.088
Subsequently, ABC has been found useful for several objects. ABC can also help address any legal conse-
other purposes, such as costing nonvalue-added activi- quences of the product-cost subsidization problem.
ties, long-term pricing, and capacity management.3
When prices are based on cost, product-cost subsi- LEGAL CONSEQUENCES FROM P R O D U C T-
dization can lead to increased demand for undercosted C O S T S U B S I D I Z AT I O N
and underpriced low-volume products, which are proba- State and federal laws have been enacted against preda-
bly being sold at unprofitable prices. Conversely, com- tory pricing, which is the selling of products below cost
panies experience reduced customer demand for as a deliberate action to drive out the competition.4
overcosted, overpriced high-volume products and ser- Alternatively, products may appear to be priced below
vices. These are unwanted economic consequences cost because of the use of unrealistic, unit-based tradi-
from product-cost subsidization that ABC seeks to cor- tional costing systems, which results in the appearance
rect by assigning indirect costs to products and services of predatory pricing where it does not exist. This
using appropriate unit-level and nonunit-level activity occurred in a case brought under the Motor Fuel Mar-
drivers that reflect resource consumption by the cost keting Practices Act of Florida.
Description Percent
Cost of Gasoline-Dispensing Facilities2 $422,000 83.9%
Rental and Other Costs Assigned to Activity Cost Pool 2, Kiosk 2,737 16.1%
Rental and Other Costs Assigned to Activity Cost Pool 3, Gasoline
Dispensing 14,263 83.9%
$17,000 100.0%
2 Asset values were obtained from the companys fixed-asset master listing.
3 If the location had mainly gasoline sales with no large, separate convenience store, this is the imputed cost of a kiosk to house an
5 The actual cost of insurance and average cost of repairs and maintenance, utilities, and real/property taxes was added to the reasonable
ing fringe benefits) of attendants, assuming that gaso- following labor, as it facilitates the payment transactions
line was the only product sold. It was decided that only that occur once per gasoline purchase.
one attendant would be required for the gasoline sales Also, it was necessary to determine a reasonable
activity in the absence of a convenience store. Multiple rental value for the gasoline-dispensing facility, which,
regression analysis results confirmed that convenience in general, can be classified as a product-level activity.6
store sales, not gasoline sales, were the major cost driver This activity cost pool includes assets that are specific
of labor cost above the base salary and benefits of one to a particular gasoline grade and common gasoline-
sales attendant. dispensing assets. In a more comprehensive activity
analysis, this cost pool could be divided into two or
Activity Cost Pool 2: Kiosk Facility and Activity Cost Pool 3: more activity cost pools that would be more homoge-
Gasoline-Dispensing Facility. Under state statutes, it was neous in nature.
necessary to determine a reasonable rental value for In determining a reasonable rental value, lease infor-
the retail gasoline facility.5 In the absence of a separate mation was obtained for the assumed rental of a kiosk
convenience store, it would be the rental value of the and gasoline-dispensing assets in comparable gasoline
kiosk. It can be argued that this is a batch-level activity, retail outlets in the surrounding geographical market
area.7 The actual cost of insurance and average cost of ing labor activity costs to the gasoline grades as follows:
repairs and maintenance, utilities, and real/property The principal responsibility of a kiosk attendant
taxes was added to the reasonable rental value.8 The would be to receive payments from customers for
total cost was divided between the kiosk facility and gasoline purchases, which is a batch-level activity.
gasoline-dispensing facility in proportion to the estimat- The volume of gasoline sold can be used as a
ed kiosk and actual gasoline-delivery assets total value proxy activity driver for these payment transac-
obtained from the companys fixed-asset master listing tions if the average volume of gasoline sold to
(see Table 2). each customer is about the same, regardless of the
gasoline grade, which appeared to be true in this
AC T I V I T Y D R I V E R S case. The volume of gasoline sold is a better trans-
The volume of gasoline sold was readily available and action proxy cost driver than the dollar sales
was selected as the proxy activity driver for both the because receiving payment from customers is not
labor and kiosk activity cost pools. The average quanti- driven by the dollar amount of the purchases. In
ties of the three grades of gasoline sold over a 14-month the case of credit/debit card payments made
period (October 1996-November 1997) were used to directly at the pump, an attendant is necessary to
assign the activity costs. This was basically the same monitor these transactions, especially if the pump
approach used by the plaintiff. The gasoline-dispensing malfunctions, such as not printing a receipt. In
activity cost pool was assigned equally to the three any case, it can reasonably be assumed that sales
grades of gasoline because each grade of gasoline had transactions of each grade of gasoline that involve
exactly the same dispensing infrastructure. an attendant directly in processing customer pay-
ments are proportionate to the total gallons sold of
Labor Activity Cost Pool. The volume of gasoline sold is a each grade of gasoline.
unit-level activity driver but can be justified for assign- The number of gasoline sales transactions will be
Gasoline-Dispensing Activity Cost Pool. The facilities used Cost Management Outcome. From a cost management per-
for dispensing the three grades of gasoline are either spective, the ABC model obtained a result that helped
common fixed assets (like the gasoline sign) or fixed to correct the problem of product-cost subsidization of
assets that are identical in size and cost for each grade low-volume products by high-volume products, which
of gasoline irrespective of the volume of gasoline sold often occurs when a pure unit-level cost assignment
(for example, the gasoline tanks). Note that the gasoline base is used. In this case, the low-volume products
tanks are identical in size and cost even though the (plus and premium gasoline) were undercosted by the
demand is considerably higher for regular gasoline ver- volume-based approach, whereas the high-volume
sus the other two grades. Table 3 identifies the major product (regular gasoline) was overcosted. Thus the
gasoline-dispensing fixed assets and whether they are regular gasoline appeared to be more costly and priced
common and/or gasoline grade-specific fixed assets. under cost because of the use of the inappropriate unit-
This commonality of some gasoline-dispensing fixed based cost assignment method.
assets with the cost equality of other, grade-specific
gasoline-dispensing fixed assets means, for example, FURTHER REFINEMENT
that if two grades of gasoline were sold instead of three, Clearly, an ABC approach improves costing in a gaso-
the reasonable rental and other long-run variable costs line dispensing retail facility, but this model could be
of the gasoline-dispensing facility would likely be one- further refined. The use of practical capacity rather
third less than is the case when three grades are sold. than expected or budgeted capacity may avoid charging
For example, one less tank excavation and gasoline the grades of gasoline for the costs of unused capacity.9
tank would be required. Also, one-third fewer pump A likely refinement would be the identification and
and tank equipment items would be needed, assuming measurement of nonunit-based activity drivers for the
each pump serves one grade of gasoline only. In terms labor and kiosk facility costs. It is important to realize
of common assets, this would likely result in one-third that more driver refinement away from unit-based