Forty-three years ago, an article was published that thoroughly demolished one of the most enduring myths of American economic history. The only sad thing about it is that some people blithely and irresponsibly ignore the message and continue to propagate the myth.
The article was entitled "Predatory Price Cutting: The Standard Oil (N.J.) Case" by Professor John S. McGee and it appeared in the October 1958 issue of The Journal of Law & Economics. It was the first time anyone bothered to scrutinize the record to see if a famous charge against a major American company actually had any validity to it.
Predatory price cutting is, in theory, the practice of underselling rivals for the purpose of driving them out of business and then raising prices to exploit a market devoid of competition. The typical history text reports that John D. Rockefeller's Standard Oil Company used it often and successfully. The charge, in McGee's words, maintains that "Standard struck down its competitors, in one market at a time, until it enjoyed a monopoly position everywhere. Similarly, it preserved its monopoly by cutting prices selectively wherever competitors dared enter." It was an allegation that McGee himself believed to be true, until he did the homework that others never got around to doing. By painstakingly examining the facts and employing piercing economic logic, McGee stripped the charge of any historical basis or intellectual substance, concluding that it was "logically deficient" and possessing "little or no evidence to support it.
A recent biography of John D. Rockefeller by popular historian Ron Chernow, entitled Titan: The Life of John D. Rockefeller, Sr., flunks both economics and history because it utterly ignores McGee's pathbreaking and definitive work and repeats the discredited predatory price cutting allegation. Chernow needs to do his homework by studying McGee's article, but all of us can benefit from reading McGee as well, not only to learn the truth about Standard Oil, but also to avoid making the same silly charge against other companies too.
By examining the record of actual prices, McGee showed that empirically, there is no reason to believe that Rockefeller achieved his high market share (90 percent of the kerosene business for a fleeting moment around 1890) by preying upon either competitors or consumers. From 1870 to 1897, kerosene fell from 26 cents per gallon to about 6 centsand the kerosene of 1897 was much improved over that of 1870.
McGee's analysis was reinforced by historian Gabriel Kolko's 1963 book, The Triumph of Conservatism. Kolko was an avowed socialist but nonetheless an historian who could look objectively at the facts. "Standard treated the consumer with deference," he wrote. "Crude and refined oil prices for consumers declined during the period Standard exercised greatest control of the industry." There was no upward spike in prices to take advantage of the absence of competitors because competitors were always present, and they substantially undercut Standard's share of the market long before the company's dissolution by the Supreme Court in an ill-advised 1911 ruling.
Predatory price cutting has always been one of those nostrums that sounds plausible in theory but collapses in reality. Some of the reasons why Rockefeller would have been foolish to employ it as a tactic bear repeating:
The large predator firm stands to lose the most. "To lure customers away from somebody, he (the predator) must be prepared to serve them himself," wrote McGee. "The monopolizer thus finds himself in the position of selling more, and therefore losing more, than his competitors." That untenable situation is further aggravated by the fact that at lower prices, consumers stockpile the product, putting off the day when the predator can "cash in" by raising his prices.
At about the same time Rockefeller was the dominant oil refiner, Herbert Henry Dow was jump-starting the Dow Chemical Company in Michigan by turning the predatory price cutting theory on its head. German manufacturers, backed by subsidies from the German government, dumped cheap bromine on the American market in an effort to run Dow out of business in the early 1900s.
Unbeknownst to the Germans, Dow simply employed agents to buy all the cheap bromine they could get their hands on. He then sold it at much higher prices prevailing in other markets in direct competition with the Germans, who eventually threw in the towel when they saw how their attempt to make Dow their prey was actually making him rich. The Dow story is one that predatory price theorists never talk about because it utterly undermines their entire case.
Consumers will increase their purchases at the "bargain prices." This factor causes the would-be predator to step up production even beyond the levels needed to keep his own customers and attract the normal amount of business done by his supposed prey. It also puts off the day when he can hope to "cash in" because as prices later rise, consumers will draw upon their stockpiles.
Competitors reappear when prices rise. A firm that embarks upon predatory price cutting never knows how long it might have to incur losses before its rivals vacate the market. But one thing is for certain: the higher prices the predator supposedly will charge when he thinks he's won the war will attract many of those rivals, and many new ones as well, back into the market.
Professor McGee concluded:
Judging from the record, Standard Oil did not use predatory price discrimination to drive out competing refiners, nor did its pricing practice have that effect. Whereas there may be a very few cases in which retail kerosene peddlers or dealers went out of business after or during price cutting, there is no real proof that Standard's pricing policies were responsible. I am convinced that Standard did not systematically, if ever, use local price cutting in retailing, or anywhere else, to reduce competition. To do so would have been foolish; and whatever else has been said about them, the old Standard organization was seldom criticized for making less money when it could readily have made more.
For those and other reasons, documented attempts at predatory pricing are extremely hard to come by and successful attempts at it are even harder to find. However, economist Donald Boudreaux, former president of the Foundation for Economic Education and now chairman of the economics department at George Mason University in Virginia, points out, "court records overflow with actual examples of how disgruntled competitors alleging predatory behavior clamor for government to hamstring their more-efficient rivals."
But as John McGee showed us 43 years ago, simply charging someone with predatory price cutting doesn't prove the case. Ron Chernow, call your history teacher.
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