See
Predatory Pricing: More Theory Than Reality. Excerpt:
"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 also to 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. And
the greater is the number of rival firms that must be pushed into
bankruptcy, the greater is the number of sales that the predator must
make at below-cost prices and, thus, the heavier are 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
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.
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."
See also
And Making Predatory Pricing Even More Unlikely…
"… is this point explained in an e-mail sent to me by Warren Smith
(pasted below; the italicized words are quotations from my article). Mr.
Smith is among the most astute and knowledgeable readers of this blog.
Here he elaborates on my recent AIER column in which I explain some of the reasons why fears of so-called “predatory pricing” are unfounded.
In support of your position, I would also suggest that:
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, implies that the firm must increase its
production of goods and services, ie., it must commit to investing in
plant, equipment and labor at an unprofitable level of sales revenue.
Once the predation is complete:
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, implies that the new higher price
levels will find a lower volume of overall sales, and correspondingly
leave the expanded plant and equipment underutilized or entirely unused.
The capital markets would recognize the inevitability of this dilemma
long before it occurred and would begin to starve the “predator” for
the capital necessary to expand.
Finishing with your point that innovation alone can create cost-sustainable expansion with reduction in costs."
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