What Does Public Schooling Teach Us About Predatory Pricing?
Public schools provide education free of charge. The result, unsurprisingly, is overwhelming market dominance. Almost 90% of school-age kids attend public school. Most people think this is a great thing. Maybe they’re right, maybe they’re wrong. Either way, though, public schooling can teach us quite a bit about predatory pricing.
Predatory pricing is one of the simplest business practices to explain: Sell at a loss until you bankrupt your competitors. When you think about it, public schools apply this predatory strategy to an extreme degree. They don’t just sell education at a loss. They “sell” education for free!
What can we learn from this epiphany? First and foremost, predation is a lot less effective than you’d think. After practicing predation to the utmost degree, public schools have only captured 90% of the market.
This is particularly striking when you realize that public schools – unlike normal businesses – can afford to practice predation indefinitely. When a normal business practices predation, competitors naturally wonder, “How long can the predator keep this up?” For private schools, in contrast, there is no light at the end of the tunnel. They keep serving 10% of the market even though they know in their bones that public schools’ predatory pricing will continue without interruption.
A further lesson: In popular nightmares, predation works because its effects are lasting. Sell at a loss, kill each and every one of your competitors, and no rival will dare to challenge you for many a moon. Once you realize that public schools currently practice extreme predatory pricing, though, it’s hard to take popular nightmares seriously.
Try this thought experiment. Public schools suddenly lose all their tax funding. (This could result from a voucher system, or just hard-core austerity). Now that schools have to cover their expenses with tuition, how long will public schools retain their 90% market share? If predation really had lasting effects, you’d expect competitors to remain scarce and scared for years, safeguarding public schools’ incumbent advantage. In practice, though, I suspect that almost everyone – regardless of ideology – would expect public schools to lose at least half of their market share over the following decade. Driving the competition out of business with insanely low prices is not akin to salting the earth so nothing ever grows there again. Not even close.
Bottom line: The example of public schools should deter any normal business from pursing a predatory strategy. If permanently giving your product away for free only yields a 90% market share, what’s the best that could happen if a normal business temporarily sold for 10% below cost? Customers should hope firms will be cocky enough to try predation. The long-run monopoly prices are sheer speculation – and the short-run discounts are undeniable. Unless, of course, your tax dollars are funding the discounts.
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I hope I can remember this example next time someone says governments have to break up monopolies because they price competitors out of business.
I used to think predatory pricing was real and justified government intervention, even though I despise government. Then I actually sat down with pen and paper (this was a long time ago) and tried working out real examples and just couldn't make it work. Every small competitor they drove out of business meant they had to raise their prices more to make up for the cost of their previous low prices, which made it that much easier for the next competitor to undercut them. And it also told big competitors that they could now undercut the predator with ordinary prices, and if that started a new round of undercutting price wars, they started out ahead of the game. It eventually occurred to me that it was like a car coasting downhill; it can never get as far up the other side because there are inefficiencies. Perpetual predatory pricing requires a better than perpetual motion machine, so to speak.
Been a long time and I've forgotten all the details, but it was just one more thing which convinced me 99% of what governments use to justify their existence is nonsense.
Insightful.