Question

The 1990s were a good time to buy CDs, mainly because discounters such as Wal-Mart and Best Buy were accumulating customers by dropping prices from $15 to $10. They were losing money, but they figured that the policy still made good business sense. Why? They reasoned that while customers were in the store to shop for CDs, they’d find other, more profitable products.

The policy was a windfall for CD buyers, but a real problem for traditional music retailers such as Tower Records. With discounters slashing prices, CD buyers were no longer willing to pay the prices asked by traditional music retailers. Sales plummeted and companies went out of business.

Ultimately, the discounters’ strategy worked: stores such as Wal-Mart and Best Buy gained customers who once bought CDs at stores like Tower Records.

Let’s pause at this point to answer the following questions:

1. Does selling a product at below cost make business sense?

2. Whom does it hurt? Whom does it help?

3. Is it ethical?

Let’s continue and find out how traditional music retailers responded to this situation.

They weren’t happy, and neither were the record companies. Both parties worried that traditional retailers would put pressure on them to reduce the price that they charged for CDs so that retailers could lower their prices and compete with discounters. The record companies didn’t want to lower prices. They just wanted things to return to “normal”—to the world in which CDs sold for $15 each.

Most of the big record companies and several traditional music retailers got together and made a deal affecting every store that sold CDs. The record companies agreed with retail chains and other CD outlets to charge a minimum advertised price for CDs. Any retailer who broke ranks by advertising below-price CDs would incur substantial financial penalties. Naturally, CD prices went up.

Now, think about the following:

1. Does the deal made between the record companies and traditional retailers make business sense?

2. Whom does it hurt? Whom does it help?

3. Is it ethical?

4. Is it legal?

Answer 1

( 1 )

Selling a product at below cost makes business sense only for a very large and financially strong firm. Such firms intentionally sell a product below cost so that the smaller firms and other competitors exit the market due to heavy losses, and in the long run the larger firm can increase the prices and act as a monopoly.

It hurts the relatively smaller firms and competitors of the larger firms. It helps the customers in the short-run and the larger or the monopoly firm in the long- run.

It isn't ethical. Many countries have laws prohibiting sale of products at below cost.

( 2 )

The deal between record companies and the traditional retailers does make business sense as collusion between the two parties would enable them to increase their prices to increase profitability. It hurts the customers as they need to pay higher prices than before. It helps the record companies and to a smaller extent the traditional retailers. However, collusion in inethical as well as illegal.