Technical Note – Pricing Below Cost Under Exchange-Rate Risk


Title of the Article : Technical Note – Pricing Below Cost Under Exchange-Rate Risk

Author Information : John Park (Whitman School of Management, Syracuse University)
Burak Kazaz (Whitman School of Management, Syracuse University)
Scott Webster (W.P. Carey School of Management, Arizona State University)

Year of Publication : Productions and Operations Management (2016)

Summary of Findings : Economists and legal professionals believe that pricing below cost is only intended to harm competition; our recently published paper shows that a rational and profit-minded firm can price below cost under exchange-rate risk. This is a persistent behavior even in the absence of competition or even if the firm is risk-averse.

Research Questions : 1. Would it ever be optimal and rational for a profit-minded firm in a monopolistic setting to set the selling price of a product or service below its marginal cost?

2. If a firm prices below cost, does it imply that it is violating anti-trust laws?

3. Should all practices of pricing below cost be classified as predatory pricing and/or dumping?

What we know : Pricing below cost is often classified as “predatory pricing” and “dumping” in international trade, and its practice is prohibited by laws (Sherman Act and Article VI.1.b.(ii) of the GATT agreement, respectively) because of the belief that it hurts competition. In dumping and predatory pricing, pricing below cost is perceived to be motivated by a firm’s desire to eliminate competitors with the intention to monopolize the market. During the practice of pricing below cost, the firm commits to losses in the short term, and once the competition is eliminated, the monopoly firm raises its price and starts accruing profits again (see Cabral and Riordan 1994, Ordover and Willig 1981, Rosenthal 1981). Earlier publications have created the intuition that a profit-minded monopolist would not charge a price below cost.

Novel Findings : While the assertion that a monopolist does not charge a price below cost is generally true, our study shows that exchange-rate risk can create an incentive for a monopolist to price below cost. This is a persistent behavior and our finding is robust because it holds true even in the absence of competition (without raising the selling price) and even when the firm is risk averse.

Implications for Practice : From a managerial perspective, our analysis shows that pricing below cost is a persistent pricing scheme that adds value to global firms; its benefits increase with higher degree of fluctuations in exchange rates.

Our work is intended, and is likely, to question the validity of how anti-trust laws are applied in global supply chain settings. Specifically, a dominant firm in a local market might have prices below marginal costs, and these may not be necessarily classified as predatory pricing practices. Similarly, global firms might end up having prices to be lower than their (expected) marginal costs; these practices may no longer be considered as violating the anti-dumping laws.

Implications for Policy: From a legal perspective, our paper introduces another possibility of pricing below cost without showing any malicious intent. It sheds light into what should be considered as legal and illegal. Therefore, our paper is likely to stimulate further discussion on the interpretation of the laws associated with predatory pricing and anti-dumping in global trade.

Implications for Society: Our work can encourage global firms to price their products and services more aggressively, and even below expected marginal costs without violating anti-trust laws. This way, these firms can reach a larger set of consumers at lower prices. And, consumers can obtain the same products and services at lower costs.

Implications on Research: Our work is likely to inspire other scholars to examine the validity of anti-trust laws known as predatory pricing and dumping from a combination of economic, legal and operational perspectives.

Full Citations : Park, J., B. Kazaz, S. Webster. 2016. Technical note – Pricing below cost under exchange-rate risk. Production and Operations Management 25(1): 153-159.

Abstract : Pricing below cost is often classified as “dumping” in international trade and as “predatory pricing” in local markets. It is legally prohibited from practice because of earlier findings that it leads to predatory behavior by either eliminating competition or stealing market share. This study shows that a stochastic exchange rate can create incentives for a profit-minded monopoly firm to set price below marginal cost. Our result departs from earlier findings because the optimal pricing decision is based on a rational behavior that does not exhibit any malicious intent against the competition to be considered as violating anti-trust laws. The finding is a robust result, because our analysis demonstrates that this behavior occurs under various settings such as when the firm (i) is risk-averse, (ii) can postpone prices until after exchange rates are realized, (iii) is capable of manufacturing in multiple countries, and (iv) operates under demand uncertainty in addition to the random exchange rate.

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Our recently published paper shows that a rational and profit-minded firm can price below cost under exchange-rate risk.

John Park

Dr. Park is formerly a visiting professor of supply chain management. He earned his PhD from the Whitman School of Management at Syracuse University, an M.A. from the Maxwell School at Syracuse University and a bachelor's degree from Anjou University in Suwon, Republic of Korea.
John Park

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