The world of venture capital, a colossal $709 billion global industry, has played a significant role in fostering the growth of tech giants such as Meta and Amazon. However, a new research paper entitled “Venture Predation” sheds light on a troubling issue in this sector. Lawyers Matt Wansley and Sam Weinstein, colleagues at Yeshiva University’s Cardozo School of Law, uncover an illegal pricing strategy that has propelled some of Silicon Valley’s biggest darlings, like Uber, to success, but at the cost of stifling innovation and reducing choice for consumers. In this article, we delve into the concept of predatory pricing, explore the emergence of venture predation, and discuss its detrimental impact on the market and the pursuit of true innovation.
The Phenomenon of Predatory Pricing
Predatory pricing is a cunning tactic employed by “deep-pocketed corporations with a large market share” to crush competitors and dominate the market. By lowering prices below cost, the predator incurs losses initially. However, once rivals are eliminated and competition diminishes, the predator raises prices to unsustainable levels, recouping its losses and establishing a monopolistic position. This practice is considered anti-competitive and is a violation of antitrust laws, which are designed to promote fair and open markets.
Challenging the Chicago School’s Argument
The Chicago School, a group of economists, once argued that predatory pricing was a rare and irrational strategy. They claimed that cutting prices temporarily removed competition but ultimately allowed new players to enter the market, offering even lower prices. However, over the years, proving predatory pricing in court has become increasingly difficult due to the influence of two critical Supreme Court cases: Matsushita Electric Industry v. Zenith Radio (1986) and Brooke Group v. Brown & Williamson Tobacco (1993). Since the latter case, no plaintiff has successfully proven predatory pricing, making it seemingly impossible to hold predatory actors accountable.
Enter Venture Predation
Wansley and Weinstein introduce a new form of predatory pricing tailored to the venture capital landscape, aptly named “venture predation.” This strategy unfolds in three steps. Firstly, venture capitalists infuse a startup (the “venture predator”) with substantial funds. Secondly, armed with this capital, the startup sets its prices below cost, driving competitors out of the market and gaining a dominant share. Finally, once the venture predator secures its position, venture capitalists and startup founders cash out through acquisitions or initial public offerings, selling their shares to investors who expect the startup to recover its losses.
The Illusion of Future Profitability
What distinguishes venture predation is its focus on creating the illusion of future profitability rather than immediate financial gains. While cutting prices below cost delays reaching profitability for the startup, venture capitalists are not concerned. Their primary objective is to attract potential investors with the promise of a lucrative exit, regardless of whether the startup achieves profitability in the long run. Uber serves as a prime example in this context, raising enormous funds, subsidizing fares, and achieving market dominance without genuine cost efficiency or a superior product.
Impact on Innovation and Consumer Welfare
Venture predation’s detrimental effects extend beyond the financial realm. Wansley and Weinstein assert that this predatory strategy misallocates capital away from genuinely innovative and socially-beneficial products. By prioritizing anticompetitive practices over true innovation, venture capitalists hinder progress and stifle creativity. The consumer, too, suffers as predatory pricing reduces choices and raises prices, resulting in lower-quality products in the market.
A Call for Change
While Wansley and Weinstein acknowledge that not all venture firms engage in predation, they caution that this practice is on the rise. By shedding light on the harmful consequences of venture predation, their research may encourage courts to reevaluate predatory pricing cases and discourage venture capitalists from pursuing such strategies. Awareness of the potential legal consequences could deter venture firms from resorting to predatory pricing as a fallback plan and encourage a more ethical and sustainable approach to investment and innovation in the venture capital landscape.