Friday, April 15, 2011

Predatory Pricing and Its Effect on Strategic Behavior of Toy Industry

Predatory Pricing on Identical Firms
To be engaged in predation, firms have to lower its price below its cost for long to drive out its rivals. That is, the firm incurs short run losses to gain long run profit. The incumbent firm has to convince its competitors to keep its price level far below cost for long to drive them out of business. But to keep prices far below cost for a long time is no easy task. In most of the cases, the firm has no ability to threat its rivals to set prices below its marginal cost and survive in the market. If the firm succeeds in driving out its potential entrants and then raises its price, new firms may again enter the market. So the dominant firm has to set its price again at lower level to drive them out. For the predation to be successful, new entrants must believe that it doesn’t pay for any potential entry due to incumbents pricing behavior.
A model of identical firms can help examine the price predation strategy (which is unlikely to become successful):
1) There are only two firms (an incumbent and entrant)
2) The two firms are identical
3) Both the firms have identical cost function
An incumbent firm has to suffer a significant loss compared to its potential new entrants during the period of predation. The predatory firm has to supply a greater output due to low prices. However, the rivals can reduce its supply to minimize its loss. As a result, the predatory firm is most unlikely to apply the strategy of predation.

Effect of Pricing on Major Toy Industries
The availability of data to assess predatory pricing effect on toy industry is very much limited. The frequency with which predation occurs in one country may be a poor indicator of its frequency elsewhere. The likelihood that a firm will attempt to predate should be influenced by legal rules and market conditions under which it operates, both of which can vary significantly. We can look at two major producers pricing strategies for their product to discuss the presence of such type of pricing (if any) in this industry.
 Compared to January, 2009, in January, 2010 U.S. retail sales for sporting goods, hobbies, books, and music stores (potential measure of toy demand) increased by 3.8%
 Mattel – first quarter, 2010 (compared to first quarter, 2009)
o Earned almost $25 million ($51 million loss in 2009)
o Sales improved due to several new product offerings and core brands, such as Barbie
 Hasbro – first quarter, 2010 (compared to first quarter, 2009)
o Sales neared $59 million (up from $19.7 million in 2009)
(Source: U.S. Department of Commerce Industry Report, 2010)

The characteristics of toy industry, and in particular the persistence of market power by dominant producers, make predatory practices a recurring possibility in this industry. As such, they are a legitimate concern for competition policy. Because the presence of low cost has such a dramatic effect on retail sales and profit level , predatory practices are especially likely to be targeted at new entrants in this industry. Although there remain threats from major producers to enter market, this industry is growing at a fast rate. The level of profit it (firm) generates is higher compared to other industry. Most often, threat of predatory pricing or non price predation can be viewed as non credible. As it is proved earlier through the help of a diagram, price predation is unlikely to generate profit for incumbent firm. The predatory firm has to suffer significant amount of loss compared to its potential new entrants. Thus, this strategy is not a profitable one for firms and little possibility to apply it in near future in toy industry.