Entry and Predation: British Shipping Cartels 1879–1929

• DOI: http://doi.org/10.1111/j.1430-9134.1997.00679.x
• Published date: 01 December 1997
• Author: Fiona Scott Morton
• Date: 01 December 1997

Entry and Predation: British Shipping

Cartels 1879–1929

F

IONA

S

COTT

M

ORTON

Chicago GSB

1101 East 58th Street

Chicago, IL 60637

fionasm@gsb.uchicago.edu

I examine the outcomes of cases of entry by merchant shipping lines into

established markets around the turn of the century. These established markets

are completely dominated by an incumbent cartel composed of several member

shipping lines. The cartel makes the decision whether or not to begin a price

war against the entrant; some entrants are formally admitted to the cartel

without any conflict. I use characteristics of the entrant to predict whether or

not the entrant will encounter a price war conditional on entering. I find that

weaker entrants are fought, where ‘‘weaker’’ means having fewer financial

resources, less experience, smaller size, or poor trade conditions. The empirical

results provide most support for the long-purse theory of predation. Due to

the small number of observations available, 47, I discuss qualitative evidence

(such as predatory intent expressed in correspondence between cartel members)

that supports the empirical results. The results are also found to be robust to

misclassification of the dependent variable, which is a particular concern when

dealing with historical data.

1. Introduction

The phenomenon of predatory pricing has interested economists for

many years. The concept of a firm ‘‘fighting’’ a rival and causing its

exit from the market is dramatic. Additionally, analysis shows that

conditions necessary for predatory pricing violate some standards of

perfect competition, making the possibility of predation controversial.

Though the contradiction inherent in predatory pricing has motivated

considerable debate, the empirical evidence has not kept up with the

This work was completed while the author was at the Stanford Graduate School of

Business. I would like to thank Doug Elmendorf, David Genesove, Jerry Hausman, Rob

Porter, John Roberts, Nancy Rose, Garth Saloner, Andrea Shepard, seminar participants

at MIT, University of Chicago, Caltech, and NBER, and three anonymous referees for

helpful comments. I am grateful for financial support from the George and O’Bie Shultz

Fund.

q1997 Massachusetts Institute of Technology.

Journal of Economics & Management Strategy, Volume 6, Number 4, Winter 1997, 679–724

680 Journal of Economics &Management Strategy

spate of theoretical contributions. This paper looks at a small sample

of price wars initiated by shipping cartels around the turn of the century

and uses characteristics of the entrants that are fought to evaluate sev-

eral theories of predation.

The Chicago school is known for the argument that predatory

pricing is unlikely to be profitable for a firm, much less for a group

of firms, and will therefore not occur. A firm expecting to gain from

predatory pricing must be able to earn excess profits (after the victim’s

exit) to pay for the price war, but excess profits are inconsistent with

perfect competition. More recent models in the game-theory literature

describe situations under which predatory pricing is rational. The long-

purse story, signaling (asymmetric information), and creation and de-

fense of a reputation are three motivations for predatory pricing. Theo-

retical work on reputation has mostly focused on the characteristics of

the incumbent (cartel) rather than the entrant. However, this paper will

concentrate on the type of the entrant and how it affects the probability

of predation.

At the turn of the century, British shipping firms operated in car-

tels that held and defended monopoly positions in various international

shipping routes. I construct a dataset for this paper that allows possible

instances of predation by shipping cartels to be examined quantita-

tively. The dataset consists of 47 cases where an entrant attempted to

break into a cartel and records which entrants precipitated a price war.

This paper seeks to understand why some entrants are ‘‘fought’’ and

others are not. Because the historical nature of the data limits the num-

ber of observations, I also include substantial qualitative evidence such

as descriptions of the practices of the shipping cartels and of industry

characteristics that made predation a likely response to entry. I also

examine entrants’ choice of market share to see if it is related to entrant

and market characteristics. This unusual opportunity to examine preda-

tion results both from the lack of contemporaneous antitrust laws and

from the propensity of the shipping industry for collusion. Although

much of the behavior I describe is now illegal, the analysis sheds light

on what firms will do if unconstrained, and thus contributes to our

positive understanding of firm behavior.

The empirical results confirm that entrant shipping line character-

istics help predict the probability of a price war: a very young firm is

a weaker entrant and is more likely to be preyed upon. The young

firms in the dataset are ‘‘weak’’ in the sense that they lack financial

resources, have little multimarket contact with rivals, lack experience,

and lack an established customer base. An additional point is that the

age of an entrant is unrelated to the state of competition, demand, or

supply shocks. This finding provides support for the idea that the price

Entry and Predation 681

wars were not simply the outcome of vigorous competition in the con-

text of demand and supply shocks. I find no evidence that long-term

contracts for cargo or government subsidies are important in determin-

ing the strength of an entrant. Nor do I find that the amount of time

since the last war occurred is relevant to the probability of predation;

this might be the case if the incumbents were trying to maintain a

reputation for preying. I do find that contracts and government subsi-

dies affect the market share at which the entrant enters, however. The

significance of entrant-specific characteristics in determining the inci-

dence of war lends support to theoretical models with the same feature.

Overall, my results provide the most support for the long-purse theory

of predation.

The organization of the paper is as follows. In Section 2 I discuss

the predation literature and the way these models could fit the behavior

of shipping cartels. Section 3 sets out the qualitative evidence for preda-

tory pricing, industry characteristics, practices, and intent.

1

Section 4

outlines the model, and Section 5 explains the variables used in the

estimation and discusses the results. Section 6 concludes.

2. Predation Literature

The amount of theoretical literature in the predation area is vast. The

position of the Chicago school provides a valuable null hypothesis and

starting point.

2

The Chicago school holds that a firm will not engage in

predatory pricing because it would have to be able to recoup its short-

run losses by earning excess profits in the long run. Those future profits

depend on its successfully driving out the entrant or rival and then

maintaining monopoly power long enough to earn back its lost profit,

which is difficult in a competitive market. For example, after successful

predation, significant entry barriers are required to prevent new en-

trants from creating competitive market conditions. Execution becomes

even more difficult should a cartel, rather than a single firm, consider

predation. The distribution of losses and gains must be arranged, and

free-rider cheating must be controlled. The proponents of this view

conclude that price wars are not evidence of predation, but evidence

of competition. If we see price fluctuations, the appropriate interpreta-

tion is that entry caused prices to drop because supply increased, and

exit caused prices to rise for an analogous reason. Cost changes or

1. The historical details of the three cartels I use in my dataset and a rough picture

of shipping-firm finances are covered in the Appendix, Sections A.1 and A.2.

2. For example, Bork (1978) and McGee (1980).