The Authors Guild recently posted a blog entry called, “The Justice Department’s E-Book Proposal Needlessly Imperils Bookstores; How to Weigh In.” To give a quick summary of the article: the Justice Department should back off their anti-trust lawsuit against Apple and the publishers being accused of collusion, because Amazon was using “predatory pricing” to eliminate competition from bookstores. Or to put it another way, even if there is illegal collusion of pricing fixing by the defendants, turn a blind eye to it, because Amazon is so much worse.
Every article I’ve read on this issue has hinged on accusing Amazon of predatory price fixing. What is that, exactly? The short answer is predatory price fixing is one company with deeper financial reserves and capital, lowering their prices on product or services they sell to below cost, with the intent to outlast their competition. Once the competition has been driven out of business, they can once again raise prices much higher than cost to recoup their losses caused by selling at below cost.
So has Amazon been guilty of predatory pricing? That would be hard to prove, because for predatory pricing to work, there has to be three conditions in play.
One, Amazon would need to have market controlling power. And most people would consider that they did and do. When the Kindle came out in 2007, Amazon blazed a new trail, combining a usable ereader with a vast selection of books easily bought on the ereader. Because they were the first to break in this market (previous attempts never had gained a significant foothold or combined a good ereader with the supply) effectively by giving the book-buying public what it wanted, they naturally had a high share of the ebook market initially. That is true of any innovation a company does that catches on. Then inevitably, more companies hop on the bandwagon and start competing with them, and market share takes a dip, maybe even sinks.
Publishers and The Authors Guild would like you to believe that it is because of agency pricing they had put in place that lowered Amazon’s market share and power. But what happened is what would be expected to happen in the normal course of competition. You can’t prove a “what if.” How do publishers know that Amazon’s market share and power wouldn’t have naturally shrunk with competition if it weren’t for agency pricing? Answer: they don’t.
However, the fact is that Amazon had, and probably still has, enough market power to pull off predatory pricing if that was their goal. But that isn’t all they need to pull off predatory pricing.
Two, Amazon would need to have a larger reserve of capital than its rivals. And by all indications, Amazon could probably outlast most, if not all, its competitors in an all out price war. Especially independently owned bookstores. Having worked for one, I know what slim margins they operate on. The overhead cost and the labor alone usually mean bookstore owners work large amounts of time so they don’t have to hire too many employees. The one I worked for lost several thousands of dollars every year it was open. It is this same reason why Borders, and Barnes and Noble put most of them out of business long before Amazon came on the scene.
But even with Barnes and Noble, the money is on Amazon to outlast them if Amazon’s purpose was to drive them all out of business. They could most likely take sustained losses for longer than the rest. But there is one last condition that needs to be present for predatory pricing to work.
Three, there needs to be solid barriers that prevent new competing businesses from starting up. For a company to use predatory pricing, it would only work if the company had dominance over the market, the capital to outlast their competitors, and they had a barrier that prevented others from coming in and starting new businesses once the competition had been eliminated.
For example, a grocery store in a city might drive their competitors out of business through predatory pricing. Perhaps the store owner has a friend on the city council, that keeps any competition from getting permits to build. So no new stores can easily enter the market. This allows the grocery store to charge as high a price as they think they can get away with because there is no competition, and they have secured a monopoly within that city. But without the ability to raise prices high without fear of anyone else coming in and undercutting them, the company would never make back the money they lost during the predatory pricing period. They would eventually go out of business themselves unless they found some way to recover that lost money and more. For predatory pricing to work, there has to be the expectation that there will be a period when the same company can raise prices artificially high to recoup their losses.
And there’s the catch. Predatory pricing is hard to prove because you have to show that the business would likely raise prices to high levels at some point to make the risk worthwhile. And the question is, does Amazon have the security to know that there are sufficient barriers to new start-ups once it could drive everyone else out of business? I think the answer would have to be a resounding no. We’re talking the Internet here. Worldwide region. There are scads of online ebook retailers still going today, most have grown since the Kindle paved the way for e-retailing. And not just because of the forced agency pricing, but due to the natural flow of capitalistic competition. It has happened with each company who has innovated new roads to travel.
What makes it additionally hard to prove predatory pricing is that there is a fine line between that and competitive pricing. Competitive pricing uses loss leaders to get people in the store in the hope and expectation that while there, they will buy other things that make a decent profit and will, overall, make the company a profit. Grocery stores have been doing this for years and years. It is focused more on getting customers into your store than it is trying to bankrupt the other stores to put them out of business.
The problem is, if Amazon was intentionally using predatory pricing to eliminate its competition, the minute they raised their prices back up enough to recoup their losses, it would open the doors for others to come in and undercut them. Then they would have to lower them back down again. It would never work, because they’d never be able to keep their prices super high without losing their market share and power to some new upstart. And Amazon knows that.
Meanwhile, there are solid facts as to why the DOJ is filing an anti-trust lawsuit. And it has nothing to do with whether Amazon is using predatory pricing or not, or will drive bookstores out of business. The publishers didn’t seem so concerned about that when they gave Barnes and Noble better deals on books than they did the independent bookstores, effectively putting hundreds of bookstores out of business. But the DOJ isn’t filing this lawsuit to help Amazon or kill bookstores.
They are doing it because there is evidence that the publishers colluded to force on eretailers agency pricing with a “favored nation status” clause that prevented Amazon or anyone from selling at a lower price than anyone else, effectively giving the publishers control of the prices and creating an oligopoly. That demonstrably resulted in the rising of prices for ebooks they controlled, to much higher levels than they had before. Meanwhile, selling product for a low price isn’t against the law. And to my knowledge, no country with a competition law has attempted to prosecute Amazon for predatory pricing. There is no evidence that Amazon has done anything illegal.
Now tell me, is it a smart defense to point to Amazon and say, “But if we didn’t do it to them first, they were going to do it to us”? That would never stand up in court. It’s the equivalent of me saying, “But judge, if I didn’t steal that car, the greenhouse gases it would have produced may have been the final straw to kick global warming into high gear.”
If that’s the total defense the publishers have, they are in for a very long dose of reality in the next few years, and they’ll probably have sunk their own boat once it is said and done. If they are right, that Amazon is trying to get total monopolistic control over the book market through predatory pricing, the publishers may have actually helped them toward that goal rather than hinder it. By breaking the law before Amazon did, the publishers may have given Amazon another potential monopoly: the supply of writers. The only result the publishers have accomplished here is the acceleration of their own demise.
If you were the CEO of Amazon, would you try to use predatory pricing to drive your competition out of business? Would it make economic sense to do so?