A key to understanding the economics of predatory pricing is to realize that the predator must lose more money than do any of its prey. The reason is that the predator can force the preys’ prices down only by taking away their customers. And to take away the preys’ customers requires that the predator expand its sales during the price war. In contrast, the prey are free to reduce their sales to levels that minimize (if not eliminate) their losses.
How, then, can predation be a lucrative strategy? The answer must be that the predator is better able than the prey to absorb price-war losses. Fortunately for consumers, predators are not better able to absorb such losses. In fact, any prey that is as efficient as the predator has just as much access to funding for the price war as does the predator....
But suppose that the observed low prices really aren’t predatory; suppose, instead, that these prices reflect the price-cutter’s superior efficiency. In this case, a mistaken belief by private investors that these low prices are predatory does no social harm. Investors lend money to a firm that doesn’t deserve the funds, while the genuinely more efficient firm keeps its prices low. Consumers never suffer. And eventually the mistake is revealed because the less-efficient firm cannot compete over the long haul with the more-efficient price cutter.
Now I see this as a rejection of predatory pricing as a social evil. Let me give a real counter example. In 2001 I was selling, amongst other services, VOIP into Poland. Unbeknown to me a second international carrier, a state carrier, was also selling into Poland. Week by week the prices dropped and week by week we matched it, until we saw that we could no longer do so. We actually had the lowest cost structure and we even went further than we should have to retain our market, but the Board said stop. Good thing, for our competitor just kept going, and against himself!
Two years later I meet the head of the same company and over lunch he recounts the tale. Allegedly he got the job because his predecessor lost $100 million on this predatory pricing scheme.
Yet what of the consumer? Both carriers were out of the market replaced by the over bloated incumbent. Prices rose, the public had no alternative, and predatory pricing had a negative effect.
Just a thought from the real world. Oh, and telecom is filled with this stuff.
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