The Myth of Predatory Pricing

Article excerpt

Any company attempting to monopolize a market by lowering its prices to such a low level that all competitors are driven out of business would be acting irrationally.

One of the oldest big business conspiracy theories--predatory pricing--was popularized in the late 19th century by journalists such as Ida Tarbell. In History of the Standard Oil Company, she excoriated John D. Rockefeller because its low prices had driven her brother's employer, the Pure Oil Company, from the petroleum-refining business. "Cutting to Kill" was the title of the chapter in which she condemned Standard Oil's allegedly predatory price cutting.

The predatory pricing argument is simple. The predatory firm first lowers its price until it is below the average cost of its competitors, who then must lower their prices below average cost, thereby losing money on each unit sold. If they fail to cut their prices, they will lose virtually all of their market share; if they do, they eventually will go bankrupt. After the competition has been forced out of the market, the predatory firm raises its price, compensating itself for the money it lost while engaged in predatory pricing, and earns monopoly profits forever after.

The theory of predatory pricing always has seemed to have a grain of truth to it--at least to non-economists--but research over the past 35 years has shown that, as a strategy for monopolizing an industry, it is irrational; that there never has been a single clear-cut example of a monopoly created by so-called predatory pricing; and that such claims typically are made by competitors who either are unwilling or unable to cut their own prices. Thus, legal restrictions on price cutting, in the name of combating "predation" inevitably are protectionist and anti-consumer.

Predatory pricing gets virtually no respect from economists, but remains a popular legal and political theory for several reasons. First, huge sums of money are involved in litigation, guaranteeing that the anti-trust bar always will be fond of the theory. During the 1970s, AT&T estimated that it spent more than $100,000,000 a year defending itself against claims of predatory pricing. It has been estimated that the average cost to a major corporation of litigating such a case is $30,000,000.

Second, because it seems plausible at first, the idea of predatory pricing lends itself to political demagoguery, especially when combined with xenophobia. The specter of a foreign conspiracy to take over American industries one by one is extremely popular in folk myth. Protectionist members of Congress frequently invoke that myth in attempts to protect businesses in their districts from foreign competition.

Third, ideological anti-business pressure organizations, such as Citizen Action, a self-styled consumer group, also employ the predatory pricing tale in their efforts to discredit capitalism and promote greater governmental control of industry. Citizen Action perennially attacks the oil industry for either raising or cutting prices. When oil and gas prices go up, it holds a press conference to denounce alleged price gouging. When they go down, it can be relied on to claim that the reductions are part of a grand conspiracy to rid the market of competitors. Even when prices remain constant, price-fixing conspiracies frequently are alleged.

Fourth, predatory pricing is a convenient weapon for businesses that do not want to match their competitors' price cutting. Filing an anti-trust lawsuit is a common alternative to competing by slashing prices, improving product quality, or both.

Finally, some economists still embrace the theory of predatory pricing. However, their support for the notion is based entirely on highly stylized "models," not on actual experience.

In 1958, economist John McGree examined the 1911 Standard Oil anti-trust decision that required John D. Rockefeller to divest his company. …