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10. Monopoly and Competition > 3. The Illusion of Monopoly Price > C. Consequences of Monopoly-Price Theory

(4) “Cutthroat” Competition

A popular theme in the literature is the alleged evil of “cutthroat competition.” Curiously, cutthroat, or “excessive,” competition, is linked by critics to the achievement of a monopoly price. The usual charge is that a “big” firm, for example, deliberately sells below the most profitable price, even to the extent of suffering losses. The firm acts so peculiarly in order to force another firm producing the same product to cut its price also. The “stronger” firm, with the capital resources to endure the losses, then drives the “weaker” firm out of business and establishes a monopoly of the field.

But, first, what is wrong with such a monopoly (definition 1)? What is wrong with the fact that the firm more efficient in serving the consumer remains in business, while consumers refuse to patronize the inefficient firm? A firm's suffering losses signifies that it is not as successful as other firms in serving consumer desires. Factors then shift from the inefficient to the efficient firms. A firm's going out of business harms no owner of any factor it employs and injures only the entrepreneur who miscalculated in his advance-production decisions. A firm goes out of business precisely because it suffers entrepreneurial losses, i.e., its monetary revenues in sales to consumers are less than the money it paid out previously to owners of factors. But so much money had to be paid out for factors, i.e., costs were so high, because these factors could earn as much money elsewhere. If this entrepreneur cannot profitably employ the factors at their given prices, the reason is that factor-owners can sell their services to other firms. In so far as factors may be specific to the firm, and to the extent that their owners will accept a reduced price and income as the price of the firm's product is reduced, total money costs can be reduced and the firm can be maintained in operation. Therefore, failure by business firms is due solely to entrepreneurial error in forecasting and to entrepreneurial inability to secure the factors of production by outbidding those firms more successful in serving the consumer.45 Thus, the elimination of inefficient firms cannot harm factor-owners or lead to their “unemployment,” since their failure was due precisely to the more attractive competing bids made by other firms (or, in some cases, to the alternatives of leisure or production outside the market). Their failure also helps consumers by transferring resources from wasteful to efficient producers. It is largely the entrepreneurs who suffer from their own errors, errors incurred through their own voluntarily adopted risks.

It is curious that the critics of “cutthroat competition” are generally the same as those who complain about the market's subversion of “consumers’ sovereignty.” For selling a product at very low prices, even at short-term losses, is a bonanza to the consumers, and there is no reason why this gift to the consumers should be deplored. Furthermore, if the consumers were really indignant about this form of competition, they would scornfully refuse to accept this gift and instead continue to patronize the allegedly “victimized” competitor. When they do not do so and instead rush to acquire the bargains, they are indicating their perfect contentment with this state of affairs. From the point of view of consumers’ sovereignty or individual sovereignty, there is nothing at all wrong with “cutthroat competition.”

The only conceivable problem is the one usually cited: that after the single firm has driven everyone else out of business through sustained selling at very low prices, then the final monopolist will restrict sales and raise its price to a monopoly price. Even granting for a moment the tenability of the monopoly-price concept, this does not seem a very likely occurrence. In the first place, it is time enough to complain after the monopoly price is established, especially since we have seen that we cannot consider “monopoly” per se (definition 1) as an evil.46 Secondly, a firm will not always be able to achieve a monopoly price. In all such cases, including (a) where not all the other firms in the industry can be driven out, or (b) where the demand curve is such that the monopolist cannot achieve a monopoly price, the “cutthroat competition” is then a pure boon with no harmful effects.

Incidentally, it is by no means true that the large firms will always be the strongest in a “price-cutting war.” Often, depending on the concrete conditions, it is the smaller, more mobile firm, not burdened with heavy investments, that is able to “cut its costs” (particularly when its factors are more specific to it, such as the labor of its management) and outcompete the larger firm. In such cases, of course, there is no monopoly-price problem whatever. The fact that the lowly pushcart peddler for centuries has been set upon by governmental violence at the behest of his more lordly and heavily capitalized competitors bears witness to the practical possibilities of such a situation.47

Suppose, however, that after this lengthy and costly process, a firm has finally been able to achieve a monopoly price by the route of “cutthroat competition.” What is there to prevent this monopoly gain from attracting other entrepreneurs who will try to undercut the existing firm and achieve some of the gain for themselves? What is to prevent new firms from coming in and driving the price down to competitive levels again? Is the firm to resume “cutthroat competition” and the same deliberate losing process once more? In that case, we are likely to find that consumers of the good will be receiving gifts far more often than facing a monopoly price.48

Professor Leeman has pointed out49 that the smaller firm, driven out by “cutthroat competition,” may simply close down, wait for the larger firm to reap its expected gain of a higher “monopoly price,” and then reopen! More important, even if the small firm is driven into bankruptcy, its physical plant remains intact, and it may be bought by a new entrepreneur at bargain prices. As a result, the new firm will be able to produce at very low cost and damage the “victor” firm considerably. To avoid this threat, the big firm would have to delay raising its price for the very long time required for the small plant to wear out or become obsolete.

Leeman also demonstrates that the big firm could not keep new, small firms out by a mere threat of cutthroat competition. For (a) new firms will probably interpret the high price charged by the “monopolist” as a sign of inefficiency, providing a ripe opportunity for profits; and (b) the “monopolist” can demonstrate his power satisfactorily only by actually selling at low prices for long periods of time. Hence, only by keeping its costs down and its prices low, i.e., by not extracting a monopoly price, can the “victor” firm keep out potential rivals. But this means that the cutthroat competition, far from being a route to a monopoly price, was a pure gift to consumers and a pure loss to the “victor.”50

But what of a standard problem brought forward by critics of cutthroat competition”? Cannot the big firm check the entry of efficient small firms by simply buying up the new rival's plant and putting it out of production? Perhaps a short period of cutthroat price-cutting will convince the new small firm of the advantage of selling out and will permit the monopolist to avoid the long periods of losses just mentioned.

No one seems to realize, however, the high costs such buying will entail. Leeman points out that the really efficient small firm can demand such a high price for its assets as to make the whole procedure prohibitively expensive. And, further, any later attempt by the large firm to recoup its losses by charging the monopoly price will only invite new entry by other firms and redouble the expensive buying-out process again and again. Buying out competitors, then, will be even more costly than simple cutthroat competition, which we have seen to be unprofitable.51,52

A final argument against the doctrines of “cutthroat competition” is that it is impossible to determine whether it is taking place or not. The fact that a monopoly might ensue afterward does not even establish the motive and is certainly no criterion of cutthroat procedures. One proposed criterion has been selling “below costs”—most cogently, below what is usually termed “variable costs,” the expenses of using factors in production, assuming previously sunk investment in a fixed plant. But this is no criterion at all. As we have already declared, there is no such thing as costs (apart from speculation on a higher future price) once the stock has been produced. Costs take place along the path of decisions to produce—at each step along the way that investments (of money and effort) are made in factors. The allocations, the opportunities forgone, take place at each step as future production decisions must be taken and commitments made. Once the stock has been produced, however (and there is no expectation of a price rise), the sale is costless, since there are no advantages forgone by selling the product (costs in making the sale being here considered negligible for purposes of simplification). Therefore, the stock will tend to be sold at whatever price is obtainable. There is no such thing, then, as “selling below costs” on stock already produced. The cutting of price may just as well be due to inability to dispose of stock at any higher price as to “cutthroat” competition, and it is impossible for an observer to separate the two elements.

  • 45. Bidding takes place among numerous firms in various industries, not only among firms in the same industry.
  • 46. An amusing instance of this concern is this argument for compulsory legal cartelization by West German industrialists: “that the so-called unrestricted competition would produce a catastrophe in which the stronger industries would destroy the weaker and establish themselves as monopolies.” Create an inefficient monopoly now to avoid an efficient monopoly later! M.S. Handler, “German Unionism Supports Cartels,” New York Times, March 17, 1954, p. 12. For other such instances, see Charles F. Phillips, Competition? Yes, but ... (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1955).
  • 47. What of the allegedly vast “financial power” of a big firm, rendering it impervious to cost? In a brilliant article, Professor Wayne Leeman has pointed out that a larger firm will also have larger volume and will therefore suffer greater losses when selling below cost. Having a larger volume, it has more to lose. What is relevant, therefore, is not the absolute size of the financial resources of the competing firms, but the size of their resources in relation to their volume of sales and expenditures. And this changes the conventional picture drastically. Wayne A. Leeman, “The Limitations of Local Price-Cutting as a Barrier to Entry,” Journal of Political Economy, August, 1956, pp. 331–32.
  • 48. After investigating conditions in the retail gasoline industry (one particularly subject to allegedly “cutthroat” competition), an economist declared:
    Some people think that leading marketers occasionally reduce prices to drive out competition so that they may later enjoy a monopoly. But, as one oil man has put it, “That is like trying to sweep back the ocean to get a dry place to sit down . ...” [Competitors] ... never scare, and never hesitate for long, and would move in immediately when prices were restored, offering little opportunity to a single marketer to recoup his losses. (Harold Fleming, Oil Prices and Competition [American Petroleum Institute, 1953], p. 54)
  • 49. Leeman, “The Limitations of Local Price-Cutting,” pp. 330–31.
  • 50. A leading oil executive told Leeman: “We have invested too much in plant and equipment in this area to want to invite in a host of competitors under an umbrella of high prices.” Ibid., p. 331.
  • 51. Leeman points out, in a striking refutation of one of the myths of our age, that this is precisely what happened to John D. Rockefeller.
    According to a widely accepted view, he softened up small competitors in the oil business by a period of intensive price competition, bought them out for a song, and then raised prices to consumers to make up his losses. Actually, the softening-up process did not work ... for Rockefeller usually ended up paying ... so handsomely that the sellers, often in violation of promises made, proceeded to build another plant for its nuisance value, hoping again to collect a reward from their benefactor. ... Rockefeller after a time got tired of paying ... “blackmail” and . . . decided that the best way to hold the dominant position he wanted was to keep profit margins small all the time." (Ibid., p. 332)Also see Marian V. Sears, “The American Businessman at the Turn of the Century,” The Business History Review, December, 1956, p. 391. Moreover, Professor McGee has shown, after an intensive investigation, that in not one instance did Standard Oil attempt “predatory price-cutting,” thus destroying the Standard Oil myth once and for all. John S. McGee, “Predatory Price-Cutting: The Standard Oil (New Jersey) Case,” The Journal of Law and Economics, October, 1958, pp. 137–69.
  • 52. Leeman concludes, quite correctly, that large rather than small firms dominate many markets, not as a result of victorious cutthroat competition and monopolistic pricing, but by taking advantage of the low costs of much large-scale production and keeping prices low in fear of potential as well as actual rivals. Leeman, “The Limitations of Local Price-Cutting,” pp. 333–34.