Donald J. Boudreaux: The Myth of Predatory Pricing

Economic reality is enormous and complex. Each and every moment brings countless actions, reactions, course corrections, and unexpected discoveries. To make sense of it all requires sound theory and a healthy knowledge of history.

Among the important tasks that sound theory and knowledge of history enable us to perform is to distinguish what’s merely possible from what’s probable. The range of all that is possible is vast. It includes, for example, your discovering next month a vaccine for cancer while modifying a recipe for turtle soup.

It is indeed possible that cancer will be prevented in this way. Yet no one in his or her right mind would leap from a recognition of this remote possibility to the conclusion that all medical research into cancer should end.

Nearly everything that is possible will never happen. Never.

The Theory

This truth is important when discussing so-called predatory pricing. Prices are said to be predatory when they are both below cost and used as a means of monopolizing a market. Superficially, fears of predatory pricing make sense. After all, if a firm today charges prices below cost, not only does it forgo profits today, its low prices also threaten the existence of its rivals. Once the predatory firm’s rivals all go out of business—voila!—the predator has a monopoly and then jacks up prices to monopoly levels. Consumers suffer unwarranted harm.

It’s possible. But this outcome is no more probable than your stumbling upon a cancer vaccine while cooking turtle soup. The reasons are many. Here are just some.

The Reality

For a firm to drive its rivals out of business by charging “excessively” low prices, it must not only cut its prices but also expand its sales. Remember, the objective is to take so many sales away from rival firms that they all go bankrupt. But when a firm increases its sales at below-cost prices, that firm necessarily incurs huge losses. The predator’s rivals, while they might all be obliged to also sell at prices below cost, have an advantage that the predator doesn’t: they can reduce their sales during the price war in order to keep their losses to a minimum.

Basic economic theory makes clear that a firm that tries to monopolize a market by charging prices below cost inflicts on itself losses larger than those it inflicts on any of the firms it’s trying to bankrupt.

Basic economic theory makes clear that a firm that tries to monopolize a market by charging prices below cost inflicts on itself losses larger than those it inflicts on any of the firms it’s trying to bankrupt. And the greater the number of rival firms that must be pushed into bankruptcy, the greater the number of sales that the predator must make at below-cost prices and, thus, the heavier the predator’s self-inflicted losses. This reality prompted Robert Bork to snarkily advise that “the best method of predation is to convince your rival that you are a likely victim and lure him into a ruthless price-cutting attack.”

Those who are desperate to portray predatory pricing as being probable respond by insisting that predatory firms have deeper pockets than do their rivals. These deeper pockets allegedly enable predatory firms to endure heavy losses while their rivals, being so very short on cash, shut down because they cannot afford even light losses.

Capital Changes Everything

This response overlooks the existence of capital markets. A core function of capital markets and their institutions (such as banks, venture capitalists, and angel investors) is to channel needed liquidity to potentially profitable firms. Firms with good track records, promising business plans, and reputable management teams have ready access to global capital markets, which are huge. (The value of outstanding commercial and industrial loans made by U.S. banks alone is now about $2.2 trillion.)

Because firms that can operate profitably over the long run routinely tap into capital markets for liquidity, each firm’s pockets are as deep as its skills are impressive, as its ideas are promising, and as its integrity is high.

Because firms that can operate profitably over the long run routinely tap into capital markets for liquidity, each firm’s pockets are as deep as its skills are impressive, as its ideas are promising, and as its integrity is high. Thus, the pockets of even the richest predatory pricer are no deeper than are those of any of its capable rivals.

Of course, it’s possible that all rivals of a predator will be unable to convince banks or other investors to supply them with needed liquidity. Possible—in the sense that this outcome can be imagined. But it is extremely improbable.

Nevertheless, assume that the extremely improbable occurs and the rich predator manages to bankrupt all of its rivals. Being now the lone supplier in that market, the predator finally has the monopoly power for which it paid so dearly.

Yet this monopoly power is worthless to the predator unless the predator now raises prices above costs in order to reap monopoly profits. So the predator does so. But prices above costs lure new entrants into competition with the predator. So bankrupting all existing rivals isn’t sufficient for the predator to secure monopoly power; the predator must also somehow prevent new rivals from competing with it after it bankrupts its previous rivals. Another round of predatory price cutting ensues, with the predator once more suffering larger losses than are suffered by any of its new rivals.

Again, it’s possible to imagine that all of the new entrants will fail—just as all of the predator’s initial rivals failed—to get sufficient liquidity and will thus be bankrupted by the predator’s low prices. But the very need to string together so many bizarre possibilities makes clear that cutting prices below costs is a fantastically unlikely means of monopolizing markets. This possibility is so remote that it should never be taken seriously.

Nevertheless, many people, including antitrust authorities and trade officials, continue to treat predatory pricing as a plausible means of monopolizing markets. Ironically, this refusal to dismiss predatory pricing as an utterly unrealistic means of securing monopoly power has a strong likelihood of itself creating monopoly power.

Government Action

Precisely because a key feature of healthy market competition is the downward pressure it puts on prices, if governments are open to acting on complaints of predatory pricing, firms that are unable or unwilling to compete fairly will seek shelter from competition by accusing their more entrepreneurial rivals of such predation. Further, fearful of being prosecuted for predatory pricing, entrepreneurial firms—even without actual complaints being leveled against them—will be more reluctant to cut their prices if governments actively police against price cutting. Economic competition is thus stymied rather than stimulated.

In this historical record, you’ll find not a single clear-cut instance of a firm securing genuine monopoly power through so-called predatory pricing.

Comb the historical record as carefully as you can. This record confirms the conclusion of sound economic theory. In this historical record, you’ll find not a single clear-cut instance of a firm securing genuine monopoly power through so-called predatory pricing.

All governments and all courts everywhere would, if they were sincerely committed to keeping markets as competitive as possible, announce loudly and unconditionally that never again will they take accusations of predatory pricing seriously.

Reprinted from the American Institute for Economic Research.

Donald J. Boudreaux


Donald J. Boudreaux

Donald J. Boudreaux is a senior fellow with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University, a Mercatus Center Board Member, and a professor of economics and former economics-department chair at George Mason University.

This article was originally published on FEE.org. Read the original article.

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34 Responses to Donald J. Boudreaux: The Myth of Predatory Pricing

  1. Chris

    And thus, orders emerge.

    Thanks for the article!
    But one quibble: in my opinion this does not take account of scale and local cost structures. The US has a huge market and manufacturers receive huge orders. Those orders are priced far below what Australian retailers can offer and then we add Australian regulatory and labour cost burdens, distributed over tiny volumes (compared to the US). Even more true for volume an shipping in small African and Pacific countries. Innovators in the US are thus privileged to sell at far lower costs to small market customers overseas, and predatory behavior is very possible without even trying.

  2. eb

    I agree with Chris’s quibble.

    Even more so when the predator is a competitor with very deep pockets, and some foreign government support.

    And good luck with convincing Governments of the victims to not support the local industry and allow large numbers of workers(aka voters) get the sack.

  3. Peter Greagg

    Yes, I also agree with the thrust of the article.
    So-called Anti Dumping action (in a trade sense), is justified on this discredited notion of predatory pricing.
    Australia is near world champion in taking Anti Dumping action against imports

  4. Pauly

    I wonder how much Austalian consumers would enjoy the Boxing Day sales if anti-dumping legislation was enforced at the retail POS?

  5. I wonder how much Austalian consumers would enjoy the Boxing Day sales if anti-dumping legislation was enforced at the retail POS?

    It’s different when we get a consumer surplus!

  6. BorisG

    well I have independently developed this theory to explain to people why the Saudis will never be able to put US shale oil our of business by selling their oil very cheaply. However key to this is one condition: entry tot he market is easy and cheap. This is true (in relative term) for shale oil and gas, but not e.g., for ultradeep water.

    here is a real life example on a different scale (a real story of England in early 1990s, but I forgot the place names).

    a route from A to B was operated by two bus lines, 1 and 2. Then line 1 (with deeper pockets) decided to slash its fares. after a while line 2 decided it wasn’t worth it and discontinued their service. After a while Line 1 increased their fares well above the original.

  7. entropy

    yes, deep pockets is not just about the specific market in operation, as Chris so ably pointed out. If a conglomerate exists in multiple markets, be it in other countries or even different product markets, it can absorb quite a large of pain in a specific market compared with the minnows.

    And then you have the market disruptors like Amazon. Not selling at a loss, but extremely low margins to profit at scale can be just as effective. It will put every small suburban specialist shop and even westfield shopping centres out of business if Bozos has his way.

  8. Tel

    But when a firm increases its sales at below-cost prices, that firm necessarily incurs huge losses. The predator’s rivals, while they might all be obliged to also sell at prices below cost, have an advantage that the predator doesn’t: they can reduce their sales during the price war in order to keep their losses to a minimum.

    Na, no one does it that way. What you do is push prices down until your nearest rivals become wobbly, then jump in an buy out a competitor. It’s faster, and a lot easier than the full scale war of attrition.

    Because firms that can operate profitably over the long run routinely tap into capital markets for liquidity, each firm’s pockets are as deep as its skills are impressive, as its ideas are promising, and as its integrity is high. Thus, the pockets of even the richest predatory pricer are no deeper than are those of any of its capable rivals.

    Sure, the capital markets can either offer angel investment for the startup (high risk) or they can offer low interest loans to facilitate the buyout of competitors (low risk). Of course they do a bit of both, but the big money goes into the buyouts.

    https://www.indexmundi.com/commodities/?commodity=chicken&months=240

    There’s 20 years worth of chicken prices on the US commodities market. Local low point in 2006 chicken prices were sitting a $1.50 per kg and soon after that Pilgrim’s Pride Corp merged with Gold Kist Inc. which was completed Jan 2007 to create the largest chicken producer in the USA and supposedly also the world’s largest poultry company. One of their main rivals had now been eliminated but they were debt heavy because they borrowed hard from these “capital markets” that are real deep n all that.

    Next two years the chicken price goes from $1.50 to $1.78 and then $1.95 which is an increase of approx 14% per annum but they were crazy years 2007 and 2008. The bounce-back happened in 2009 when Pilgrim’s Pride Corp hit chapter 11 bankruptcy, unable to carry the debt load, especially after the GFC and the downturn. However, chicken prices never went back down to $1.50 and Pilgrim’s Pride Corp did struggle along, traded their way through the chapter 11. How did they make it back to profitability? They sold a big chunk of the company to JBS of Brazil… Oh, and they shut down production, laid off workers and generally reduced supply in their industry.

    Chicken prices have been quite volatile in the past few years but the are currently spiking at $2.62 per kg and if you calculate the increase from the low point during 2006 up to current price (over 12 years) you get an average increase of approx 5% per annum which is not too bad when you consider that chicken farming is essentially the same business now that it was 100 years ago and official inflation rates have been around 2% per annum.

    Now I’m not saying this is a good business strategy, but it really does happen. A few large chicken producers have been able to create higher prices (and higher volatility) where a large number of small producers were delivering low prices and low volatility. Admittedly, there was a significant financial crisis in the middle of that, but the fact that suppliers went through hard times is no comfort to the buyers who need to eat and are also going through tough times.

  9. entropy

    Tel agree with all but

    which is not too bad when you consider that chicken farming is essentially the same business now that it was 100 years ago and official inflation rates have been around 2% per annum.

    You know nothing, Tel.

    The chicken meat industry is nothing like back then.

  10. stackja

    John D. Rockefeller?

  11. .

    Next two years the chicken price goes from $1.50 to $1.78 and then $1.95 which is an increase of approx 14% per annum but they were crazy years 2007 and 2008. The bounce-back happened in 2009 when Pilgrim’s Pride Corp hit chapter 11 bankruptcy, unable to carry the debt load, especially after the GFC and the downturn. However, chicken prices never went back down to $1.50 and Pilgrim’s Pride Corp did struggle along, traded their way through the chapter 11. How did they make it back to profitability? They sold a big chunk of the company to JBS of Brazil… Oh, and they shut down production, laid off workers and generally reduced supply in their industry.

    If you did not factor in energy prices, grain prices, the USD, other main meat price cross elasticities and the stock of broiler chickens, then all you have is a hunch.

    The openness of a market, not necessarily concentration determines oligopolistic pricing or not.

  12. .

    stackja
    #2765129, posted on July 16, 2018 at 9:44 pm
    John D. Rockefeller?

    This is a bogeyman. Jared Diamond wrote about this.

    Rockefeller’s competitiveness saw oil prices go down to an eighth of what they were before he came along.

    So even if he charged “monopoly” prices, he pushed the industry cost curves so low that end users and industrial users paid near 90% less than beforehand.

  13. stackja

    And all lived happily ever after?

  14. JABL

    But then we have Amazon’s behaviour. As an example ToysRUs. Although this may just be an example of the failure of the Courts to craft a proper award of damages

  15. What if a retailer who has a large range of products sells some of them at predatory prices whilst maintaining overall margins. He can select the products he sells more cheaply to target a specific rival and put him out of business. This process is repeated to remove the next rival.

  16. .

    stackja
    #2765137, posted on July 16, 2018 at 9:52 pm
    And all lived happily ever after?

    Why the aggressive stupidity?

  17. .

    Gerard
    #2765158, posted on July 16, 2018 at 10:17 pm
    What if a retailer who has a large range of products sells some of them at predatory prices whilst maintaining overall margins. He can select the products he sells more cheaply to target a specific rival and put him out of business. This process is repeated to remove the next rival.

    Name one retailer that does this.

    Besides, the internet is killing these dinosaurs even if they wanted to do that.

    If every firm is selling different products at different margins but maintaining an overall margin, this is great. People are “suffering” near perfect price discrimination and it is almost as good as perfect competition, but we know dynamically that costs can be lower due to lower scale economies.

    You don’t mention why firms could possibly price so low in the first instance. You do not consider that ANYONE pricing below marginal cost never is profitable nor do you consider if there are no barriers to entry, what happens. What do you think has happened to Harvey Norman since about the time Australia got widespread broadband internet access?

  18. entropy

    What do you think has happened to Harvey Norman since about the time Australia got widespread broadband internet access?

    he did the time honoured Australian big business trick: he lobbied the Australian government to make it too much bother for OS competitors to sell to Australia.

  19. Rebel with cause

    Harvey Norman makes most of its money from products too heavy to make online sales worthwhile. Couches, dining tables, beds, fridges, big tvs, carpets etc. Yes they have an electronics counter but that was a shrinking part of the store long before Amazon came along. Harvey wasn’t lobbying for GST because online sales had a big impact on his profit margins but because he is a senile old coot with a hobby of rodgering middle Australia good and hard.

  20. John Constantine

    Their abc predatory pricing their Fairfax and their guardian and their crikey out of the market?.

  21. Tel

    You know nothing, Tel.

    The chicken meat industry is nothing like back then.

    Go on and explain to me the latest great technological breakthrough in cutting the head off a chicken and pulling the giblets out. Remember that none of the companies I discussed actually farm any chickens, so don’t bother talking about barns or feeders of any of that.

  22. Chris

    Harvey Norman makes most of its money from products too heavy to make online sales worthwhile.

    ‘Harvey Norman stores’ are actually malls of separate but co-branded franchise businesses. The small appliances are one, the TVs and hifis another, computers a third, and furniture a fourth.

  23. Tel

    What if a retailer who has a large range of products sells some of them at predatory prices whilst maintaining overall margins. He can select the products he sells more cheaply to target a specific rival and put him out of business. This process is repeated to remove the next rival.

    You see this model in things like the Sony Playstation.

    So they sell a very powerful computing platform at an excellent price, but then you are locked into paying the Sony tax on each and every game. I think the name is “cross subsidizing” which is getting a foot in the door then lock people into that system then catch the money back over the lifetime of the product.

    The other example would be car parts… if you build a car out of parts it cost about three times as much as a new car containing the exact same parts. Obviously, once you buy a car, you are committed to buying compatible parts so the ability to shop around is curtailed.

  24. Tim Neilson

    The predator’s rivals, while they might all be obliged to also sell at prices below cost, have an advantage that the predator doesn’t: they can reduce their sales during the price war in order to keep their losses to a minimum.

    Is this real? I can see how it might work for variable costs. But what if the rivals have substantial fixed costs? How would minimising sales during the price war keep them afloat?

    Any Cats who know how to run a business care to comment?

  25. .

    So they sell a very powerful computing platform at an excellent price, but then you are locked into paying the Sony tax on each and every game. I think the name is “cross subsidizing” which is getting a foot in the door then lock people into that system then catch the money back over the lifetime of the product.

    That is not a valid analogy. At all.

    When the PS1 came out, it was 700 AUD to buy and games were around 100 AUD and some arcade ports were worth 120-130 AUD.

    The other example would be car parts… if you build a car out of parts it cost about three times as much as a new car containing the exact same parts. Obviously, once you buy a car, you are committed to buying compatible parts so the ability to shop around is curtailed.

    It is cheaper to mass produce. That is the main reason, but also price discrimination. It makes sense to buy a $150 belt tensioner on a 10-year-old car. It may not be worth it buying a new cloned engine. The aftermarket parts are not necessarily mass produced.

  26. .

    Is this real? I can see how it might work for variable costs. But what if the rivals have substantial fixed costs? How would minimising sales during the price war keep them afloat?

    Smaller rivals have lower fixed costs. The bigger players with lower minimum efficient scales have higher start-up costs.

  27. All well and good but this article doesn’t seem to consider small businesses.
    I have been watching in real time my local Woolworths put 3 small businesses out of business.
    The local bakery was the first to go. WW started selling french sticks and bread rolls at half the price of the local bakery, then the price of vienna bread and tiger bread dropped. The bakery shut down for over a month and recently re-opened under a new franchisee. But the sales volume seems to be crashing.

    Same thing is happening to the butcher who also shut down. The green grocer survives only because he does what most Middle East immigrant businessmen do, he deals in cash, employs mostly family members and makes less than minimum wage per person per hour but the total family income is what sustains them.

    So although I agree with the general thrust of the article, I don’t think it fully applies to local small businesses struggling against the giant supermarkets.
    That’s my anecdotal story.

  28. old bloke

    For a firm to drive its rivals out of business by charging “excessively” low prices, it must not only cut its prices but also expand its sales.

    This assumes that the two competitors have equal costs. This doesn’t hold true if a large supermarket chain, for example, is able to dictate prices to farmers, dairymen, etc., through their larger purchasing power, whereas the smaller supermarket chain has to pay more for the items they resell.

    Similarly, sweetheart deals with the Unions does inflict higher operating costs on the smaller retailer whose employees are outside the corporate / union sweetheart deals.

    Level playing fields are a myth.

  29. .

    This assumes that the two competitors have equal costs

    No, dead wrong. It assumes they have different cost structures.

    Level playing fields are a myth.

    No. Australian farmers are getting stupendous prices at the moment.

  30. .

    The green grocer survives only because he does what most Middle East immigrant businessmen do, he deals in cash, employs mostly family members and makes less than minimum wage per person per hour but the total family income is what sustains them.

    So what? He isn’t screwing over the public with liquor licenses or the plastic bag scam. He’s supporting his family. What a guy.

  31. Pauly

    well and good but this article doesn’t seem to consider small businesses.
    I have been watching in real time my local Woolworths put 3 small businesses out of business.
    The local bakery was the first to go. WW started selling french sticks and bread rolls at half the price of the local bakery, then the price of vienna bread and tiger bread dropped. The bakery shut down for over a month and recently re-opened under a new franchisee. But the sales volume seems to be crashing.

    Same thing is happening to the butcher who also shut down.

    My local butcher started selling premium store made sausages, smoked his own bacon. He’s had to put on extra staff and has bought out the shop next door. We had 2 bakeries, one has become a chain bakery, the other now specialuzes in gluten free bread, quinoa muffins and has some tables were people can sit and drink complementary organic coffee.

    The small businesses that value added and expanded into niches the supermarkets can’t access did very well.

  32. So what? He isn’t screwing over the public with liquor licenses or the plastic bag scam. He’s supporting his family. What a guy.

    What the hell is wrong with you dot?
    I didn’t criticise the bloke, I explained how and why he manages to survive in his small business.
    Sheeesh!!!

  33. Pauly
    #2765646, posted on July 17, 2018 at 2:54 pm

    The small businesses that value added and expanded into niches the supermarkets can’t access did very well.

    Spot on Pauly and I agree. I have however highlighted the key word in your statement.
    Niche being niche, for every small biz that did well, 5 or more others didn’t. They can’t all target niche markets……… by definition.

  34. .

    The implication that you need to cheat to compete with the oligopoly is not true.

    There are chain stores that compete under the nose of an oligopolist supermarket, as that larger shop is needed as an anchor in malls.

    Franchise chain bakeries and so on are publicly traded and tend to obey strict financial reporting rules.

    The chain shops do get more trade from being near the anchor but pay fairly high rent. We know there is a good chance they have to be fairly straight on the accounts.

    The oligopoly, on the other hand, does not cheat on costs or pricing, but rather, setting market conditions regarding zoning and liquor licenses.

    We can safely assume that the bigger corporations have even higher failure rates. They’re what is leftover out of the successful smaller businesses to begin with.

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