Why I Don't Fear Predatory Pricing

by Don Boudreaux on July 12, 2007

in Antitrust

My recent posts (here and here) on antitrust matters brings this question, by e-mail, from someone named Rhonda: "How can you be sure that dominant firms like Whole Foods do not use their privileged position to underprice their weaker rivals.  It seems to me this tactic is used often."

Here’s an article that I wrote several years ago (with Jim Gattuso) explaining my reasons why I never worry that so-called "predatory pricing" will ever lead to consumer harm.  (The article is rather long; the germane part of it is the section entitled "The Economics of Predation.")

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{ 17 comments }

Bret July 12, 2007 at 3:25 pm

Whereas I agree that predatory pricing is extremely rare and that the government should not bother intervening, I think the analysis in "The Economics of Predation" is incorrect in certain cases. In certain industries, it is NOT true that the assets of the bankrupt are not destroyed. For example, if a California citrus grower goes bankrupt and doesn't water his trees (happens fairly often), the trees die in short order. It takes many years and a substantial investment to replant and begin producing citrus again.

If there were widespread bankruptcies due to foreign dumping, the foreign entities would, in theory, have plenty of time to recoup the loses incurred during the predatory pricing period.

shawn July 12, 2007 at 3:47 pm

…if the trees die in short order w/o water, we shouldn't be growing trees there in the first place, because the microclimate can't sustain those trees.

We, in Florida, don't need to beat ourselves up much to grow citrus trees w/o water (once they're established trees)…except in relatively rare droughts. The trees may suffer w/o pruning/harvesting for a season or two, but I'm pretty sure they wouldn't become firewood.

Swimmy July 12, 2007 at 4:29 pm

It's kind of funny how one of the most beneficial acts of competition–the lowering of prices–looks to a non-economist. Indeed, sellers try to undercut each other all the time, but not to the outcome your reader thinks.

Bret July 12, 2007 at 5:09 pm

Florida oranges are juice oranges. Dry climate oranges (California, Texas, Spain, Australia, etc.) are grown as table fruit. It's a completely different industry with limited overlap.

python July 12, 2007 at 5:23 pm

I am afraid of predatory anonymous disinformation :-)

See the Whole truth here (get it, "Whole" truth. Now that's a pun.)
http://biz.yahoo.com/ap/070712/whole_foods_online_comments.html?.v=2

shawn July 12, 2007 at 5:37 pm

Sorry bro…we sell plenty of table fruit oranges. Y'all have thicker-skinned, "prettier" oranges.

And, I'd bet, you've only got oranges because you get water subsidies.

I'm not arguing that there's a difference, and cali oranges "look" better…but maybe they shouldn't be being grown at all, and therefore this *particular* example of your point (though I take the point as valid, in general, and worth more thought) quibbling with Don's initial "capital is not destroyed in the prey's organization" could be discarded without throwing out the whole issue.

Atabrat July 12, 2007 at 5:57 pm

As a side note to the other part of the question, Whole Foods generally has a 3% profit margin, while most large grocery chains (and many of them now sell the same products as Whole Foods) generally have a 1% profit margin. It hardly seems as though they are underpricing anyone.

JohnDewey July 12, 2007 at 7:31 pm

Don, thanks for the link to your DOT comments.

If predatory pricing were an effective weapon for fortress hub carriers, we should have seen at least one earn sustainable profits. But all of them – except for Wright-Amendment-protected American Airlines – have been bankrupt at some point in the past 20 years. Even with its protected hub, American was on the court house steps a few years ago, just minutes from Chapter 11.

Sam Grove July 12, 2007 at 7:37 pm

"It seems to me this tactic is used often."

Seems!? SEEMS!?

Seems to me that Rhonda picked up her opinion at the philosophical yard sale.

Bret July 12, 2007 at 9:26 pm

shawn wrote: "…but maybe they [California Oranges] shouldn't be being grown at all…"

It's a product that makes a small profit that many people buy and enjoy. Yes, it requires water. Most products require some sort of material input (otherwise they'd be a service), so what's the difference?

Besides, any sort of living thing that dies and takes an extended period and substantial investment to recreate falls under the same category (other orchard products, livestock, etc.)

shawn July 13, 2007 at 7:53 am

bret…if, and I believe this is the case, they [california farmers] receiving water at extremely low cost [lower than anyone else in the state, who pays rather high water prices] because of government mandate, then that's the issue. It's that water is at a premium in southern california, and farmers are growing crops that are way out of whack. It is, essentially, a farm subsidy…protectionism, of a sort, designed to keep 'california citrus growers' competitive. If they had to pay market rate for their water, they wouldn't be growing as many (or any) of those pretty oranges, and would be focusing on something else…?agave?…do y'all have any nice southern california tequila?

I didn't realize that this was the case, until I saw Walter Williams writing on it occasionally. I can find an article of his and point you toward it, if you'd like.

Dan July 13, 2007 at 6:03 pm

Shawn,

Dr. Sowell kind of covers it here.
http://www.jewishworldreview.com/cols/sowell031904.asp

Stephen Reed July 13, 2007 at 7:34 pm

Isn't one of the flaws in this analysis that the competitor is at least as efficient as the established firm? At the very least, an upstart firm has higher costs of capital than an established firm due to greater risk. Additionally, some firms might have an absolute advantage in some area that a competitor can not emulate.

Usually the idea is to drive out the competition before it has a chance to become as efficient as itself (due to economies of scale, for example, which can take a long time to establish all necessary relationships with retailers and brand recognition to sell a sufficient quantity to reach minimum efficient scale).

JohnDewey July 13, 2007 at 8:46 pm

Stephen Reed,

I used to believe that economies of scale and brand recognition were insurmountable obstacles for upstarts. In theory, that makes sense. The past three decades demonstrated otherwise. Consider Southwest Airlines, WalMart, FedEx, and Dell. They had neither economies of scale nor brand recognition when they decided to take on industry giants.

shawn July 14, 2007 at 12:30 am

dan…thanks man; maybe it was sowell…that does look familiar. I've been reading so much of the both of them lately that I've apparently gotten confused.

….'preciate the backup.

Paucus July 19, 2007 at 6:13 pm

Take the case of Boeing and Airbus. If one managed to bankrupt the other, would it ever again arise once the prices shot up? Once the engineers are sent home and the govt intervention, how likely is it to be put together again? If Boeing did not get all the contracts from NASA and support from all 50 senators, would it compete with Airbus, which itself receives subsidies?

Aimee Berry December 16, 2007 at 3:24 pm

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