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Predatory Pricing and Ebooks

May 17, 2012

By Teresa Oswald

Debate about ebook pricing has dropped off recently as there has not been much progress on the antitrust lawsuit brought by the DoJ in April, but the ideas behind the disagreement have not changed much. Central to the defense of the ebook publishers is the allegation that Amazon was a bad actor and engaged in predatory pricing, so their actions were justified. If we assume those allegations are true (and according to Amazon’s testimony in the DoJ’s court filings, they are not), it is not as ironclad a defense as the publishers seem to think it is.

Predatory Pricing

Predatory pricing is when a company sets its prices low in order to drive its competitors out of business. After it is the only company in a market, it then raises its prices to a monopoly price. Generally the predatory company loses money on everything it sells in hopes that the future gains from monopoly pricing will be enough to make up for the loss.

In the United States, predatory pricing by itself is not illegal, but may be deemed anticompetitive and subject to antitrust lawsuits if it is deemed to be harmful to the consumer. This is similar to the fact that it is not illegal to have a monopoly in the United States, but it can be subject to antitrust suits if the monopolist engages in abusive practices.

The Supreme Court sets the standards for prosecuting predatory pricing extremely high, and there has not been a successful prosecution for predatory pricing since the 1993  case Brooke Group v. Brown & Williamson Tobacco where the practice was found (6-3) to be legal as there was no way to prove that Brown & Williamson’s Tobacco would raise its prices after undercutting its competitors. Without solid proof of intent to raise prices to above the competitive price, there was no case.

Why it won’t Work with Ebooks

Predatory pricing only works if the predatory company can create and maintain a monopoly. The primary reason why predatory pricing actually works in some markets is because the barriers to entry are high. That is to say, if the predator does get a monopoly, unless it is hard to create a new business that can compete, or there are government regulations prohibiting entry, the predator will not have a monopoly for long.

Bookstores are no more difficult to make than any other retailer. Ebook stores are similarly inexpensive, as the cost of renting space is replaced by web site design and server cost. There is no doubt that if Amazon tried to raise its prices to above the competitive price, competitors would enter the market and sell for lower—unless, of course, all the major publishing companies signed agreements to fix prices at those levels.

Another factor that disallows for holding a monopoly in the current market is independently and self-published ebooks. There is no lack of authors and freelance editors alike, and it requires very little up-front cost to create an ebook, especially the low-quality 99 cent books. Although there are many authors who write purely for financial gain, there are plenty of authors willing to write for personal enjoyment.

The Publisher’s Loss is the Consumer’s Gain

The other argument about predatory pricing is that it hurts publisher’s profits by forcing prices down. This may be true, but it has no implications for welfare.  Every dollar the publisher ‘loses’ from lower prices is another dollar the consumer gets to keep (possibly to spend on more books). Quantities of goods, not prices, determine welfare.

With something that has virtually no marginal cost, like an ebook, the publisher does not necessarily make less profit by selling at a lower price. When marginal costs fall, so too does the profit maximizing price, and booksellers could make up in volume what they lose in price per sale.

According to the DOJ filing, publishers feared $9.99 e-book prices would lead to lower hardcover book sales and lead to consumers expecting lower prices for retail books. Publishers wanted prices high to protect hardcovers, not to maximize profits in the ebook market. Unfortunately, colluding to raise prices is very much illegal, not to mention a misguided attempt to control a change in the market brought on by the increased popularity of ebooks.

Conclusion

The situation today very much mirrors the situation under Brook vs Brown & Williamson, and I find myself agreeing with the Supreme Court’s decision on that matter as well as this one—as long as there is no provable harm to the consumer, predatory pricing itself is not anti-competitive behavior. Even if Amazon did manage to drive out all other publishers from the market, it would not be able to raise its prices afterwards because there are no significant barriers to entry in the book retail market. In the end, it just isn’t a good defense.

Further Reading:
Predatory Pricing is extremely difficult to pull off

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