Friday, 30 October 2009

Low prices are bad!

This comes from Mark Perry's blog Carpe Diem. Perry writes
From the American Booksellers Association letter to the Antitrust Division of the U.S. Department of Justice:

We ask that the Department of Justice investigate practices by, Wal-Mart, and Target that we believe constitute illegal predatory pricing that is damaging to the book industry and harmful to consumers.

As reported in the consumer and trade press this past week,,, and have engaged in a price war in the pre-sale of new hardcover bestsellers, including books from John Grisham, Stephen King, Barbara Kingsolver, Sarah Palin, and James Patterson. These books typically retail for between $25 and $35. As of writing of this letter, all three competitors are selling these and other titles for between $8.98 and $9.00.

The retailers are, in fact, taking orders for these books at prices far below cost. (In the case of Mr. King's book, these retailers are losing as much as $8.50 on each unit sold.) We believe that, Wal-Mart, and Target are using these predatory pricing practices to attempt to win control of the market for hardcover bestsellers.

Authors and publishers, and ultimately consumers, stand to lose a great deal if this practice continues and/or grows. If left unchecked, these predatory pricing policies will devastate not only the book industry, but our collective ability to maintain a society where the widest range of ideas are always made available to the public, and will allow the few remaining mega booksellers to raise prices to consumers unchecked.

We urge that the DOJ investigate and request an opportunity to come to Washington to discuss this at your earliest convenience.

Perry responds to all this by saying,
In other words, according to the booksellers, the "sky is falling," and the very foundations of our civilization are about to be destroyed by the rapacious book pricing policies of Amazon, Wal-Mart and Target. Where to start?

1. How exactly are low book prices "harmful to consumers?" Consumers have several remedies at their disposal to combat the "predation" whenever they feel they are being harmed by low prices: a) refuse to buy the book from Amazon or Wal-Mart for $9 and instead pay full price from an independent bookseller, b) refuse to buy the book at all, or c) offer to pay more than the "predatory" price from the "predator." That last option might not work so well at Amazon or Wal-Mart (if the book is priced at $9, it might be hard to actually pay $20 instead - how would the cashier ring it up?), but there might be some cases where a consumer could pay more than the listed price.

2. Keep in mind that about 90% of antitrust investigations involve one firm or group of firms complaining about one of their more efficient, low-cost competitors, like in this case.

3. Assuming that the predation worked and Amazon, Target and Wal-Mart were able to successfully drive all of the independent booksellers out of the market, there would be two problems:

a) They would still have to compete against each other and it could remain an intensely competitive book market even without the independents, to the continued benefit to consumers and

b) if the three oligopolists (Amazon, Target and Wal-Mart) did conspire to raise book prices to "book scalping" or "book gouging" levels, they could then: i) face antitrust charges, this time for high anti-competitive "monopoly" prices, and/or ii) face new competition from firms re-entering the market from the attractive "smell of profits" emanating from the monopoly pricing.

4. Notice in the Amazon listing above (click to enlarge) that Amazon offers "free shipping" on orders over $25, which is obviously below its actual cost. Isn't that then "predatory shipping?" Should that be investigated by the Dept. of Justice?

5. Also notice in the Amazon listing that there are more than 30 new copies of the Grisham book available from small, private booksellers at prices starting at $4.25, or more than 50% below Amazon's price of $9.59. Aren't those small booksellers engaged in predatory pricing AGAINST Amazon?
The point to remember when you see complaints about "predatory pricing," is that predatory pricing is basically a myth for which there is virtually no real-world examples of it ever being successful, harmful to consumers, or leading to anti-competitive behaviour in the long run. Low prices are not bad!

As I have noted before, Louis Phlips suggests that the necessary conditions for predatory pricing are,
To sum up, economic theory suggests that predatory pricing is a real possibility only when the following five conditions are simultaneously met:
1 The aggressor is a multimarket firm (possibly a multiproduct firm).
2 The predator attacks after entry has occurred in one of its markets.
3 The attack takes the form of a price cut in one of the predator's markets, which brings this price below a current non-cooperative Nash equilibrium price at which the entry value is positive for the entrant (possibly below a discriminatory current Nash equilibrium price with the same property).
4 The price cut makes the entry value negative (in present value terms) in the market in which predation occurs.
5 Yet the victim is not sure that the price cut is predatory. The price cut could be interpreted by the entrant as implying that its entry value is negative under normal competition. In other words, the victim entertains the possibility that there is no room for it in the market under competitive conditions.
It seems unlikely that such conditions are ever met in the real world and such conditions also mean that it is unlikely that competition agencies will find a robust and simple rule to use to detect predatory pricing. Most just seem to fall back on the old presumption that firms with market power are always suspect. William Landes tells the story about why Ronald Coase gave up antitrust,
“Ronald [Coase] said he had gotten tired of antitrust because when the prices went up the judges said it was monopoly, when the prices went down they said it was predatory pricing, and when they stayed the same they said it was tacit collusion.”

–William Landes, “The Fire of Truth: A Remembrance of Law and Econ at Chicago”, JLE (1981) p. 193.
It's only in the strange world of competition policy that any price you charge can be considered illegal.


Economists Do It With Models said...

I don't generally think that predatory pricing is pervasive in firms, but it's important to remember that even a threat of predatory pricing could preclude entry by competitors if they viewed the threat as credible. Therefore, it's not obvious that a switch to monopoly pricing would induce entry.

Mark said...

Try living in Blenheim and flying to Wellington (or anywhere for that matter) regularly. Then come back and tell me why the theory and the reality don't match.

Paul Walker said...

For an empirical analysis of predatory pricing see John Lott's book "Are Predatory Commitments Credible?: Who Should the Courts Believe?", Chicago: University Of Chicago Press, 1999. Are predatory commitments credible, short answer, no.