“Kill them all” is rarely a goods plan

Two years ago, I wrote a Troppo post on Coles’ decision to sell milk for a dollar a litre.

I took particular aim at the claim by consumer group Choice that regulators should investigate whether Coles is engaged in predatory pricing. Said Choice: “It is difficult to see why any retailer would sustain such losses if it were not seeking to eliminate or damage its competitors”. Said me: Shouldn’t a consumer group know a little about how retailers operate?

My view was that Coles’ decision looked more like an implementation of the basic retail strategy known as “low-high” – price the basics like milk and bread cheaply, advertise the heck out of those basics, get people into the store, and then rely on them buying items which have more margin in them: frozen blueberries, dishwashing powder, ready-to-cook kebabs, flea collars, Tom Cruise DVDs, broccolini.

In July 2011, the ACCC rejected Choice’s predatory pricing claims and said the milk price cuts were good for consumers.

It looks to me like time for the ACCC (and me) to declare victory. Two years on, milk is still cheap, not just at Coles but at Woolworths and Aldi and IGA. Coles’ strategy is widely viewed within the industry as a success for the company, but there’s still plenty of competition to sell milk to you and me. And of course low-income people have cheap access to food basics. This hasn’t been the Choice organisation’s worst call, but it might make the top ten.

Choice’s dodgy claims about milk are just one example of a broader belief in what we’ll call the kill-them-all business plan, which seems common among consumer advocates. This is the idea that companies or industries can drive all of their competitors out of business, take over and charge what they like. The problem is that this rarely happen in real life, except in a small list of very special circumstances. Predatory pricing is generally very tough to pull off.

There are ways in which companies can control markets, but they are more common in  service industries and they generally fit one of several well-known profiles:

  • The market is a natural monopoly. This is an issue in all sorts of infrastructure markets. Think of parking at Australian airports, or electricity transmission.
  • The market started with a giant government player. That was the case for the Victorian electricity industry and for national fixed-line telecommunications before the 1990s. One market (Victorian electricity) was redesigned fairly well under former state treasurer Alan Stockdale; the other (telecommunications) is still a regulatory mess, with a new monopoly player being put in place.
  • The market is subject to lock-in, often because people use the product to interact. Think Microsoft Office, which evolved into people’s default choice because they had to share files with other people. This is one case of a product market where competitors really are pushed out over time. For what it’s worth – and it might not be worth that much – consumers get a benefit (interoperability) as well as higher costs. These markets don’t stay monopolies forever – hello Google Drive! – but they can last a long time.

Feel free to nominate more special cases in the comments.

But in general, companies struggle to control goods markets. When you see someone claiming they can, it seems to me best to take a deep breath and then ask: how, exactly? If the answer is “they’ll slowly drive all their competitors out of business”, you might want to be sceptical.

Update, May 2016: A colleague pointed out another problem with predatory pricing: since it is an extremely long-term strategy, you have to also believe that the companies doing it are capable of running very long-term strategies. Not everyone believes that this is very easy for many companies to do.

Oh, and in May 2016, milk is still a dollar a litre. After five years I think we can say that if this is predatory pricing, it’s a) failed and b) hard to walk away from. Note to people trying to corner a market by cutting prices: your strategy runs a substantial risk of failure.

About David Walker

David Walker runs editorial consultancy Shorewalker DMS (shorewalker.net), editing and advising business and government on reports and other editorial content. David has previously edited Acuity magazine and the award-winning INTHEBLACK business magazine, been chief operating officer of online publisher WorkDay Media, held policy and communications roles at the Committee for Economic Development of Australia and the Business Council of Australia and run the website for online finance start-up eChoice. He has qualifications in law and corporate finance. He has written on economics, business and public policy from Melbourne, Adelaide and the Canberra Press Gallery.
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TN
TN
8 years ago

Feel free to nominate more special cases in the comments.

I’m not sure that the market for consumer advocacy is a special case, but it does seem to be one in which anti-capitalist dogma often drives out economic sense.

Richard Tsukamasa Green
Richard Tsukamasa Green(@richard-green)
8 years ago

Again on Microsoft office, I’m not sure they can ever be said to have taken a loss on it, even in the short term, as a strategic interest. They always seemed to be charging above cost (even average cost, marginal cost being miniscule with software).

That may have been their intent with Internet Explorer, but we a) don’t see that strategy making them any money and b) we still have competition from multiple open source and commercial browsers.

Another example is Amazon, which apparently is trying this with other booksellers (apparently, because there’s no other strategy to explain what they’re doing), but with no sign of it happening any time soon.

Predatory pricing was one of my intended entries in “Things that might not matter” (1, 2), but some of the best examples overlapped with my professional work – even though the conclusions weren’t really at odds. Like the other entries there’s many theoretical examples where it plausibly could occur under the right examples, but I can’t think of a single, definitive, real world example.

desipis
8 years ago

My pet concern is how companies can manipulate consumers into acting against their own best interests. Once consumer behaviour is sufficiently diverted from self-interested rational choices ideological assumptions about market efficiency go out the window.

desipis
8 years ago

Loss leaders, like cheap milk, being a well worn example of manipulating consumers by distracting them away from consideration of what they ought to be concerned about (total cost of purchases) to something that is of minor consequence (cost of just the milk) causing them to act against their own rational best interests (selecting a store that minimises cost of milk rather than total cost of purchases).

Thomas the Tout
Thomas the Tout
8 years ago

And last month, down here in rural SA, yet another dairy farm is in receivership. Most of the large dairies are making a financial loss, month by month. Smile all you like about being correct that cheap milk is good for consumers – ignorance is bliss.
Perhaps also look at the ‘Spring Gully’ case. An Adelaide manufacturer of preserves is in administration; possibly squeezed off the shelves of some big supermarkets. After the story surfaced many people sought out the products, and bought them. But I suppose concoctions from some asian country are better for the consumer, because they are cheaper – or make a bigger margin for someone up the supply chain.

Pedro
Pedro
8 years ago

I’m not sure the ACCC will join you in the victory parade, I’m sure I recently heard Rod Sims fretting about fuel vouchers.

You might have to drop the airport parking from you list, I’m pretty sure that Brisbane is under pricing pressure judging from their signs out there, but perhaps I don’t fly and drive enough to be sure.

“Once consumer behaviour is sufficiently diverted from self-interested rational choices ideological assumptions about market efficiency go out the window.”

Whoa, what a lot of faith you have in the average consumer. How can you think that self-interest rational choices was ever much of a factor?

David Walker
David Walker
8 years ago
Reply to  Pedro

Just to be clear, I’ve no doubt there’s plenty of things out there for the ACCC to worry about. And attempts to manipulate consumers are real (though frequently far less effective than the would-be-manipulators would like). I’m simply arguing that actual predatory pricing in goods markets – that is, an effective scheme to drive all your competitors out of business – seems to be rare.

Mr T
Mr T
8 years ago

A couple of comments.

As David Walker has just said, the article is about how often predatory works, not the structure of the dairy industry in Australia.

Secondly, I have not seen any hard data that Coles is actually selling milk as a loss leader. While they do not make as much from their own brand milk, they have used their market power to drive down the wholesale price. This was the first part of their “own brand” strategy, which had been a successful strategy in overseas countries since the 80’s. (I think Tescos in the UK does this well) Prior to this campaign, both Coles and Woolworths had generic brands that were cheap but of inferior quality. With this campaign Coles put their own name on generic goods, quality controlled them to a much higher extent and went head to head with their suppliers.

They were forced to do this because companies like Aldi, who had successfully implemented this strategy overseas, were beginning to enter the Australian market.

Milk was a prime candidate for this strategy. It was highly overpriced compared to the farm gate price of milk. The milk industry had for a long time been protected. During that time, the farmers massively improved their productivity, leading to a massive oversupply compared to the domestic market. (Australia was by no means alone in this. The European “Butter Mountain” was legendary). The response was to produce milk products for export. The price received for these products was very low compared to the price received for local milk. The farm gate milk price was set by government, and the wholesale milk price I think was also set so as all the participants were profitable.

As protection was would back, domestic milk prices did not fall. But the farm gate price has continued to fall as export sales dropped off. So we have an industry with overcapacity, a shrinking export market, and a price for it’s end product artificially high because of a previous large but cross subsidised export market.

With the $1 per litre milk campaign, milk reached the supermarkets at price closer to what it should be if “the dairy industry” did not support an uneconomic dairy export sector.

Added to this, milk suppliers found a way to make their Coles milk cheaper by using “permeate” a previously low value or waste product. There has since been a concerted push to demonise this, but sales would indicate that this has failed.

derrida derider
derrida derider
8 years ago

I was once, a long time ago, quite active in Choice. I still believe a strong organisation lobbying for consumer interests would improve this country quite a bit, but Choice was never and will never be such a beast. “Economic ignoramuses” best describes them – the last straw for me was when they put a submission in SUPPORTING tariffs on cars.

A century of empiric studies of it shows that actual predatory pricing is indeed rare and requires rare conditions to succeed – which does not prevent failed attempts being somewhat less rare (it’s amazing how bad many businesses are at strategy). Most commonly it is threatened to keep out new entrants in natural oligopolies – the classic case in Australia is domestic airlines. But precisely because the threat is only credible where there is in fact a natural oligopoly the net cost of this behaviour to consumers is not large and may well be negative, “unfair” as it may be.