Predatory pricing
Published by Yazad Jal April 11th, 2005 in EconomicsA lot of cellular operators are unhappy about Reliance Infocomm offering unlimited talktime tariffs (Reports in the Hindu Business Line and Business Standard). They’ve gone crying to TRAI calling it unfair and “predatory”. They’re wrong.
Firstly, it’s not predatory pricing. Note the explanation from Wikipedia:
Predatory pricing is the practice of a dominant firm selling a product at a loss in order to drive some or all competitors out of the market. The other firms must lower their prices in order to compete with the predatory pricer, which causes them to lose money, eventually driving them bankrupt. The predatory pricer then has fewer competitors or even a monopoly, allowing them to raise their prices above what the market would otherwise bear.
Emphasis mine
The assumption is that Reliance will first drive all the other operators out of business, corner the market and then raise prices astronomically. Well, we should rest assured as it will never happen. Not because Reliance won’t do it (I’m not a spokeperson for them), but because if they do increase prices, the market will be full of new lost-cost providers.
Here are two illuminating pieces. The Myth of Predatory Pricing talks of the famous Rockefeller / Standard Oil case and Herbert Dow, the Monopoly Breaker shows how easy it was to break a large cartel’s attempt at predatory pricing.
The pink papers don’t talk about it, but has anyone noticed that the complaints of predatory pricing are coming from Reliance’s competitors not its consumers? Saurabh Jain on the india-gii list points out that
As far as the consumer is concerned, aren’t they [Reliance] the only telco doing what we all want? Lower tariffs, higher (unlimited) usage on fixed monthly payments, better quality, all possible telco services, etc.
He’s right. My advice to the whining telcos is to focus on improving their products and services instead of attacking competitors who offer consumers a better deal.
Again Yzad you are theoretically correct but practically dead wrong.
Do you know how much infrastructure and sunk costs it takes to set up a cellular network - two towers every 3 miles - and thats just the start. In your fantasy scenario new cell phone providers miraculously appear out of nowhere and suddenly start offering services. In reality it will take years and years to set up a netowrk and that assuming these new entrants in the market have millions lying around just waiting to be used to set up a network.
You need to differentiate a bit between products before trying to apply your theiries universally. Your theory works if two vendors were selling onions or even if there were two or more competing shops - but does not scale to cellular networks.
This is backed up by looking at the US cell phone industry where there is major consolidation going on - so much so that now there are only about 4 major players left in the market and cell phone call prices in the US are ridiculously high compared to the rest of the world averaging about 0.25c/min (yes there are deals and plans et al.)
Reliance Infocomm has been responsible for a dramatic cuts in cell call rates. Theirs was a very well thought-out entry strategy with just the right media blitz - showing the huge investments they were making in telecom infrastructure, and leaked stories of amazing discounts they got from vendors like Nortel and Accenture, as reasons why they (and implicitly) only they could make a profit at the “cheaper than a postcard” rates. And this was at a time when the biggest player, BTVL, was still struggling to make a profit. This was then.
Today BTVL is making some of the biggest profits in India Inc (at least in its size category), while Reliance Infocomm is wallowing in losses (and has plans to offload almost a million customers).
A company with bad strategy can, not just ruin itself, but also the industry. For example, one match fixer can ruin fan interest big time in a sport. If Reliance goes down it will be a big blow for the industry as a whole in the longer run. So it is incorrect to say that lower prices, which the consumers love and competitors dont, is always good for the industry.
Having said that, if TRAI does not believe a pricing pattern is predatory, I would tend to believe them.
Yazad, ofcourse you forget that Reliance made a back-door entry into the cellular market without paying the huge licence fees, as other players did.
Not only that, they also tamper with CLIs and illegally route international calls as STD or locals thus avoiding dues to MTNL/BSNL. The only thing TRAI does is asks them to pay fines just “equivalent” to the amt they have pilferaged(sometimes even less). They don’t account for the fact that Reliance’s entire customer-base is solely because of these low-entry costs.
I won’t even start providing the links. Google does a better job.
And I have seen it personally when my friend from US used to call Bangalore using Reliance India Calling Cards.
Ofcourse we know, most corporates employ smart techniques to avoid tax and such, but it doesn’t even come close to broad daylight robbery and loot like this. What is that they say abt..”doing by day what others do by night”. That it is.
CK, you correctly point out that there’s a high entry cost for operators in the cellular industry. It doesn’t materially change my hypothesis. If Reliance jacks up prices after cornering the market, the high entry costs (in lieu of future profits) will be bearable for new players. Of course that threat might encourage Reliance to keep prices low. In which case consumers should be happy!
Suhail, I don’t condone Reliance’s unethical practices and I think they should be punished for all the fraud they’ve perpetuated. But in this case, they’re not wrong, and it’s the other cellular operators who’re whining.
Woot, Reliance seems to be as revered as the Walmart in US, and also seems to be as efficient, which is I guess, the reason why it’s the recipient of so much whining.
Ck:
You do not seem to getting the irrationality of predatory pricing — thus it would be you who is wallowing in a theoretical world as opposed to practicalities.
Now predatory pricing is where the company sells at a loss or where its prices are just above its marginal (including running interest) cost i.e. it has a barely sustainable profit margin.
Consider the case where the predatory company hasn’t broken even. If the capital cost is high as for e.g. in telcos, this low pricing entails a far more distant break-even.
Now, I presume you might deem this unacceptable only if the company requires a monopoly to sustain and/or break-even.
Considering that this was a high capital cost venture, the running interest costs would be huge; this is practically suicidal!
If you ask me, it’s in high capital cost ventures that it would be even more irrational for a company to keep its prices unsustainably low.
If on the other hand, one company’s *sustainable* price is above the other companies’ due to various reasons (cf. Walmart, Reliance) asking it should jack up its price to the higher levels of its competitors seems ridiculous to the point of hilarity. Ck: Are you suggesting that?
Yazad your statement
is bases on what study. Have you or has anybody actually run teh numbers to see if this in fact true. You would like it to be true but is it reall?
Seve times six - a classic example of long term predatory pricing is the cable television distributors (in the US at least). There are only a coupel of cable companies now and its impossible for any other player to enter in - why - because all of the lines have already been laid down years ago at great expense. It is virtually impossible for a new player to break into the market because of teh huge costs involved in laying down hundred of miles of cable. As a result the American consumer pays some of the highest costs in the world for cable V - usually aboyt $40/month (Thats about Rs. 1500/month - don’t know what teh price is in India now but it was nowhere even close to that when I was there last).
So what does one do now? The cable companies have long since broken even (some of the cabling was done in the 70s).
YOu have to consider teh facts in markets where there are huge barriers to entry and infrastructure whose life span in measure in decades not year.
As I understand it, predatory pricing is pricing your product so low that your competitors are driven out of business, with the intention of raising it later once you are a monopoly. If you follow this definition, any price could be predatory. You could be making a profit and your pricing could still be predatory because your competitors can’t match you.
CK, if you read the first linked article, you’ll learn that the idea of predatory pricing exists entirely in the realm of theory and there hasn’t been a single documented case of successful predatory pricing. Who’s getting all theoretical now? In the current example, it is silly to even think that Reliance will get into a predatory price war what with Tata in the fray.
Predation does not have to occur merely because of pricing it can also occur when a player comes in early and lays the hevy infrastructure. There are huge upfront costs for it and not anybody has those kind of resources lying around. You can argue that continued monopoly is the reward for being the first off teh bloc - but in the end the consumer suffers.
There are in fact numerous examples of this:
- cable TV
- Internet services
- cellular services
and ter eis no shortage of govt. egs as well
- subway systesm
- water supply
- electricity
all of teh abpve require large anounts of infrastructure and very often space is also an issue ( you can have 3 diff pvt systems in one city)
So now you’ve redefined predatory pricing to mean “natural monopoly”?
Ck, your cable example is a switching tactic — you’re talking about consolidation rather than predatory pricing. I don’t think Comcast drove other cable companies out by predatory pricing — it just bought them out via mergers.
One could then argue about the problems of monopolies in large infrastructure products, but that is still orthogonal to the point of the above post which you were contesting:
that predatory pricing is actually irrational, and there is no single documented case of success via predatory pricing.
I suggest you read this paper
I read that too, but what has that got to do with Reliance?
Ravkiran said
Slight clarification. That should read, “As I understand it, predatory pricing is pricing your product below your costs so that your competitors are driven out of business and future entrants are deterred.
The key is below costs. i.e. the low prices are not a result of manufacturing or distribution efficiencies.
In general, it is quite difficult to separate instances of predatory pricing from instances of innovation and competitive price cuts. Companies have an incentive to lie about their costs. Additionally, there is always the possibility that the regulator involved could be influenced through outright bribery or political favors in deciding whether a company is guilty of predatory pricing, given that the issues involved are very complex and necessarily involve a judgement call. In any case, I don’t see any evidence here that Reliance is doing anything more than engaging in what is standard practice in the mobile industry in other countries.
In regards to CK’s remarks about the U.S. cellular market, comparing prices (especially of non-traded services) across countries is frought with so much difficulty that in general I take such comparisons with a grain of salt. A half-liter of Coke is also more expensive in the U.S. than in India: is this because of insufficient competition in the American soft-drink industry?
Most cell phone users in the U.S. pay a fixed rate and get alloted minutes every month. There are advantages and disadvantages to this compared to pre-paid plans but competition and flexibility in pricing schemes mean that U.S. consumers have access both options (incidently, I figure that I pay about 10 cents per minute; a far cry from the 25 cent figure CK gives, which can only plausibly refer to pre-paid plans).
While I haven’t had a mobile phone for very long, my impression is that the price of talk-time has almost certainly been going down over the long-run in spite of the fact that there are only a few companies with national markets in the U.S.
Yes Quizman, I know that and that was my point. The real crime is not that someone is selling below cost, the real crime is supposed to be that once they drive competitors out of business, they will raise prices and enjoy monopoly profits. You can supposedly do this even if you’ve driven away competitors by entirely legitimate means, i.e. cutting costs and competing on price.
I’m wondering why purchasing power parity was left out while comparing US rates to Indian? Consider that, and the so called predatory priced US rates are not so awful after all!