Predatory pricing

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Predatory pricing also known as price predation is an economic phenomenon whereby a company lowers its prices (possibly below costs) in an attempt to drive rivals out of the market.[1] The predatory firm is then expected to increase prices, after competitors have been forced out of the market, to a level that allows them to recoup any losses incurred during the predation period. In many countries this is viewed as an anti-competitive practice and can subject suspected predatory firms to prosecution under anti-trust laws. While similar in name, this phenomenon is distinct from predatory lending.

Arguments for why predatory pricing would not occur in free markets

With few empirical examples of successful predatory pricing[1], many economists still hold the view that predatory pricing leads to the possibility of market failure. However, there are a number of arguments as to why under a capitalist economy firms would not undertake a predatory pricing strategy successfully[1][2]:

  1. The recouping of losses, which is essential for a predatory pricing strategy, may not occur because rival firms could just exit the market when prices are lowered and re-enter when prices are increased.
  2. Even if rival firms are forced out of the market when prices are increased by the predatory firm, this could induce new competitors into the market.
  3. The predatory firm must have a supply large enough to meet all demand at the lowered price. If its capacity is not great enough, prices will rise again.
  4. If the predatory firm were to repeatedly lower prices when rivals re-entered the market, the rival firms could short the dominant firms stock in an attempt to make up for losses resulting from the lower price.

Example

Herbert Dow invented a more efficient process to separate bromine and sold it to other firms, which made it into sedatives and photographic supplies. Dow and other Americans sold bromine inside the U. S. for 36 cents.

Internationally, a powerful German cartel, Die Deutsche Bromkonvention, had been the dominant supplier of bromine since it first was mass-marketed in the mid-1800s. This cartel fixed the world price for bromine at a lucrative 49 cents a pound. Customers either paid the 49 cents or they went without. The Bromkonvention made it clear that if the Americans tried to sell elsewhere, the Germans would flood the American market with cheap bromine and drive them out of business.

By 1904, Dow was ready to break the unwritten rules and decided to sell in Europe. He easily beat the cartel’s 49 cent price and sold America’s first bromine in England. Before long, the Bromkonvention poured bromine into America at 15 cents a pound, well below its fixed price of 49 cents, and also below Dow’s 36 cent price.

Dow worked out a daring strategy. He had his agent in New York discreetly buy hundreds of thousands of pounds of German bromine at the cartel’s 15 cent price. Then Dow repackaged the German product and sold it in Europe—including Germany!—at 27 cents a pound. "When this 15-cent price was made over here," Dow said, "instead of meeting it, we pulled out of the American market altogether and used all our production to supply the foreign demand. This, as we afterward learned, was not what they anticipated we would do."

The confused Germans kept cutting U. S. prices—first to 12 cents and then to 10.5 cents a pound. Dow meanwhile kept buying the stuff and reselling it in Europe for 27 cents. Even when the Bromkonvention finally caught on to what Dow was doing, it wasn’t sure how to respond. As Dow said, "We are absolute dictators of the situation." He also wrote, "One result of this fight has been to give us a standing all over the world . . . . We are in a much stronger position than we ever were . . . ."

When Dow broke the German monopoly, all users of bromine around the world could celebrate. They now had lower prices and more companies to buy from. This victory propelled the remarkable Dow to challenge the German dye trust, and, after that, the German magnesium trust. His successes in these industries again lowered prices and helped liberate the American chemical industry from its European stranglehold.[3]

References

  1. ↑ 1.0 1.1 1.2 Spulber, Daniel. "Famous Fables of Economic – Myths of Market Failures", 2002, page 20-21.
  2. ↑ Kelly, Kel. The Case for Legalizing Capitalism, 2010, page 173-174.
  3. ↑ Burton W. Folsom. "Herbert Dow, the Monopoly Breaker", Mackinac Center for Public Policy, May 1, 1997. Referenced 2011-11-19.

Links

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