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Loss Leading as an Exploitative Practice

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  • Rey, Patrick
  • Chen, Zhijun

Abstract

Large retailers, enjoying substantial market power in some local markets, often compete with smaller retailers who carry a narrower range of products in a more efficient way. We find that these large retailers can exercise their market power by adopting a loss-leading pricing strategy, which consists of pricing below cost some of the products also offered by smaller rivals, and raising the prices on the other products. In this way, the large retailers can better discriminate multi-stop shoppers from one-stop shoppers — and may even earn more profit than in the absence of the more efficient rivals. Loss leading thus appears as an exploitative device, designed to extract additional surplus from multi-stop shoppers, rather than as an exclusionary instrument to foreclose the market, although the small rivals are hurt as a by-product of exploitation. We show further that banning below-cost pricing increases consumer surplus, small rivals’ profits, and social welfare. Our insights apply generally to industries where a firm, enjoying substantial market power in one segment, competes with more efficient rivals in other segments, and procuring these products from the same supplier generates customer-specific benefits. They also apply to complementary products, such as platforms and applications. There as well, our analysis provides a rationale for below-cost pricing based on exploitation rather than exclusion.

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Bibliographic Info

Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 10-218.

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Date of creation: 23 Nov 2010
Date of revision: Dec 2011
Publication status: Published in American Economic Review, vol.�102, n°7, 2012, p.�3462-3482.
Handle: RePEc:tse:wpaper:24035

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Keywords: loss leading; exploitative practice; retail power;

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References

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  1. Bolton, P. & Brodley, J.F. & Riordan, M.H., 1999. "Predatory Pricing: Strategic Theory and Legal Policy," Discussion Paper 1999-82, Tilburg University, Center for Economic Research.
  2. Marie-Laure Allain & Claire Chambolle, 2007. "Loss leaders banning laws as vertical restraints," Post-Print hal-00242935, HAL.
  3. Lal, Rajiv & Matutes, Carmen, 1994. "Retail Pricing and Advertising Strategies," The Journal of Business, University of Chicago Press, vol. 67(3), pages 345-70, July.
  4. Skidmore, Mark & Peltier, James & Alm, James, 2005. "Do state motor fuel sales-below-cost laws lower prices?," Journal of Urban Economics, Elsevier, vol. 57(1), pages 189-211, January.
  5. Roman Inderst & Christian Wey, 2003. "Buyer Power and Supplier Incentives," CIG Working Papers SP II 2003-05, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG).
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  7. Zhiqi Chen, 2001. "Dominant Retailers and the Countervailing Power Hypothesis," Carleton Economic Papers 01-05, Carleton University, Department of Economics, revised 2003.
  8. Oecd, 2007. "Resale below Cost Laws and Regulations," OECD Journal: Competition Law and Policy, OECD Publishing, vol. 9(1), pages 169-255.
  9. Mark Armstrong & John Vickers, 2010. "Competitive Non-linear Pricing and Bundling," Review of Economic Studies, Oxford University Press, vol. 77(1), pages 30-60.
  10. Roman Inderst & Tommaso M. Valletti, 2011. "Buyer Power And The ‘Waterbed Effect’," Journal of Industrial Economics, Wiley Blackwell, vol. 59(1), pages 1-20, 03.
  11. Cleeren, Kathleen & Dekimpe, Marnik G. & Gielens, Katrijn & Verboven, Frank, 2008. "Intra- and Inter-Format Competition Among Discounters and Supermarkets," CEPR Discussion Papers 6964, C.E.P.R. Discussion Papers.
  12. Weinstein, Jonathan & Ambrus, Attila, 2008. "Price dispersion and loss leaders," Theoretical Economics, Econometric Society, vol. 3(4), December.
  13. Patrick REY & Thibaud VERGE, 2009. "Resale Price Maintenance and Interlocking Relationships," Working Papers 2009-11, Centre de Recherche en Economie et Statistique.
  14. Weinstein, Jonathan & Ambrus, Attila, 2008. "Price Dispersion and Loss Leaders," Scholarly Articles 4589708, Harvard University Department of Economics.
  15. Walsh, Patrick Paul & Whelan, Ciara, 1999. "Loss leading and price intervention in multiproduct retailing: welfare outcomes in a second-best world1," International Review of Law and Economics, Elsevier, vol. 19(3), pages 333-347, September.
  16. Bliss, Christopher, 1988. "A Theory of Retail Pricing," Journal of Industrial Economics, Wiley Blackwell, vol. 36(4), pages 375-91, June.
  17. Claire CHAMBOLLE, 2005. "Stratégies de revente à perte et réglementation," Annales d'Economie et de Statistique, ENSAE, issue 77, pages 59-79.
  18. T. Randolph Beard & Michael L. Stern, 2008. "CONTINUOUS CROSS SUBSIDIES AND QUANTITY RESTRICTIONS -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 56(4), pages 840-861, December.
  19. Weinstein, Jonathan & Ambrus, Attila, 2008. "Price Dispersion and Loss Leaders," Scholarly Articles 4685158, Harvard University Department of Economics.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. “Loss Leading as an Exploitative Practice,” Z. Chen & P. Rey (2012)
    by afinetheorem in A Fine Theorem on 2013-07-12 04:27:32
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Cited by:
  1. Noriaki Matsushima & Akira Miyaoka, 2013. "Who benefits from resale-below-cost laws?," ISER Discussion Paper 0875, Institute of Social and Economic Research, Osaka University.
  2. Roig, Guillem, 2014. "Informative Advertisement of Partial Compatible Products," TSE Working Papers 14-483, Toulouse School of Economics (TSE).
  3. Chen, Zhijun & Rey, Patrick, 2013. "Competitive Cross-Subsidization," TSE Working Papers 13-450, Toulouse School of Economics (TSE).
  4. Rosato, Antonio, 2013. "Selling Substitute Goods to Loss-Averse Consumers: Limited Availability, Bargains and Rip-offs," MPRA Paper 47168, University Library of Munich, Germany.
  5. Johansen, Bjørn Olav, 2012. "The Buyer Power Of Multiproduct Retailers: Competition With One-Stop Shopping," Working Papers in Economics 03/12, University of Bergen, Department of Economics.
  6. António Brandão & João Correia-da-Silva & Joana Pinho, 2010. "Spatial competition between shopping centers," FEP Working Papers 394, Universidade do Porto, Faculdade de Economia do Porto.
  7. In, Younghwan & Wright, Julian, 2014. "Loss-leader pricing and upgrades," Economics Letters, Elsevier, vol. 122(1), pages 19-22.
  8. Smith, Howard & Thomassen, Øyvind, 2012. "Multi-category demand and supermarket pricing," International Journal of Industrial Organization, Elsevier, vol. 30(3), pages 309-314.
  9. Rhodes, Andrew, 2011. "Multiproduct pricing and the Diamond Paradox," MPRA Paper 32511, University Library of Munich, Germany.

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