What is Predatory Pricing?

Predatory pricing is a strategy of setting prices low in an attempt to eliminate competition. Predatory pricing is usually temporary. However, there is a threat of creating a monopoly in the market. Low prices will eliminate some of the competitors, and all consumer attention will be focused on one brand with low prices. It is difficult to establish a monopoly in any market, but an oligopoly is quite possible.

In this article we will talk about how predatory pricing works, what long-term and short-term consequences can be, we will give examples, and also talk about the legal side of predatory pricing.

The economic theory of predatory pricing is that companies may prefer to charge less profitable prices in the short term, but this does not mean that profits must be negative.

Indeed, some predatory pricing practices may not be profitable in the short term, but there are times when a company can afford to suffer losses without hurting the business too much in the long run. Such companies can be highly successful compared to their competitors.

After prices are lowered, some competitors are eliminated, and the dominant company can then raise prices in order to recoup their earlier losses. To achieve this, market power can be an important factor.

But after a company has increased its prices, it may again lose its market dominance. In that case, their brand will be replaced by others that offer lower prices. It can be a vicious circle.

Let's take a closer look at what predatory pricing can lead to in the short and long term.

In the short term, predatory pricing hurts the company, but it is very beneficial for customers: they can buy products at a low price, and they can shop around. Over time, other competitors may begin to respond to one brand's low prices and lower their own prices as well.

As a result, many brands lower prices and try to win customers. The company that survives this competition will be able to profit from market dominance and recover their losses.

In the long run, the company that has taken over the market begins to raise prices and recover their losses. In this situation, consumers suffer, as there are practically no alternatives on the market.

After some period, other companies may appear that offer goods cheaper, and competition will resume.

The easiest way to understand how predatory pricing works is through examples.

Walmart raised its price on several generic drugs to $9 for a 30-day supply in some states. "We don't know for certain whether it can make a profit on the $4 drugs so they don't violate these [predatory pricing] laws," said John Rector, NCPA senior VP and general counsel. "But we strongly doubt it, and the fact it is [raising some prices] gives us insight into what its business practices are."

We will talk about the law and what measures are being taken against predatory prices a little later. But what is important is that in some US states there is a ban on predatory pricing. That’s why Walmart then got into trouble with the law.

In 2001, Air Canada faced allegations of predatory pricing against two smaller competitors (WestJet and CanJet) by Canada’s Commissioner of Competition. Air Canada introduced special fares to match competitor’s prices of $89 to $99. In the past, the airline had priced such flights at more than $600.

Other airlines filed complaints regarding Air Canada’s anti-competitive behavior, and a representative of the company’s corporate development and strategy department came out and stated: “We are not aware of any precedent anywhere where an airline has been prevented from matching pricing.”

In this specific case, Air Canada explained that they were matching prices and were not engaged in predatory pricing.

Amazon has long been accused of predatory pricing. The company has turned down profits, instead preferring to expand its network. But is it possible to determine whether prices are predatory, when the price is considered acceptable, and when it is illegal?

Amazon sometimes sells books at very discounted prices. In 2013, it became clear that Amazon.com was ready and even able to sell print and e-books at a price that was considered very low among their competitors — i.e., physical stores. This was a situation where a giant e-commerce company could buy books in bulk at a deep discount, and the price at which they sold the book to end consumers was the purchase price for offline stores.

This was predatory pricing on Amazon's part, as with this pricing strategy it successfully built up sales and slowly but steadily eliminated its competitors one by one.

If we're talking from a legal standpoint, the US Supreme Court has held that for prices to be predatory, they must be below the seller's cost.

The main reason for predatory pricing is a price war. The goal is simple: to take advantage of low prices and drive out competitors.

A predatory pricing strategy is not for everyone: only large, stable firms can afford such a strategy, because such pricing requires the company to incur losses for a period. This strategy will be successful for a company only if it can later take advantage of the full price and make a profit.

It is very important to know the legal aspects of predatory pricing. Of course, the approach to predatory pricing may differ in different countries.

Predatory pricing practices can lead to attempts to monopolize the market, and resulting antitrust claims. Companies with dominant or significant market shares are more vulnerable to antitrust requirements. However, because antitrust law is ultimately designed to benefit consumers, the US Supreme Court has placed high barriers to antitrust lawsuits based on predatory pricing theory. The court requires plaintiffs to demonstrate the likelihood that pricing practices affect not only competitors, but competition in the market as a whole, in order to establish that there is a significant likelihood that the monopolization attempt will succeed. If there is a chance that market participants will not allow the predator to recoup their investment through ultra-competitive pricing, then there is no chance of success and the antitrust suit will fail. In addition, as previously mentioned here, in order for prices to be predatory, they must be below the costs of the seller.

However, the US Department of Justice argues that modern economic theory based on strategic analysis considers predatory pricing as a real problem and argues that the courts are outdated and too skeptical.

In Europe, the relevant law is Article 102 of the Treaty on the Functioning of the European Union, which reads as follows: “Any abuse by one or more enterprises of a dominant position in the internal market, or a significant part of it, should be prohibited as incompatible with the internal market, since this may affect trade between Member States."

If Article 102 is violated by predatory pricing practices, the European Commission can intervene. According to the Article 10 Application Guidelines, the Commission usually intervenes in possible cases of predatory pricing if a dominant firm seeks to maintain or strengthen its bargaining power by “sacrificing” short-term losses to disqualify “equally efficient” competitors or even “less efficient” competitors. The situation is the same as in the US.

Limit pricing is still legal, as prices are set slightly above costs. This is not as radical a strategy as predatory pricing, and the effect is slightly different.

Predatory pricing is aimed at the complete suppression of competitors and is illegal. Limit pricing simply diverts the customer's attention to one brand and tends to make other brands invisible, but is not meant to create a monopoly.

And to build a correct pricing policy, you can use Price Intelligence Software.

Price discrimination is a pricing policy in which the same product or service is sold at different prices to the same or different consumers.

An important sign of price discrimination is that the difference in price is not justified by production costs, logistics costs or transportation costs.

Predatory pricing, in turn, unnecessarily lowers prices for all buyers, since the main goal of such a strategy is to eliminate competitors and gain power in the market.

A predatory price is a price for products / services below production/distribution costs, which leads to losses. Predatory prices may attract legal attention if the brand begins to increase its bargaining power. Brand competitors may also notice predatory prices, because their customers will go to another company. In this case, most likely other companies will accuse the brand of predatory pricing.

A price that is below cost is a price at which a company incurs losses, since more money is spent on the production and distribution of the goods than the company charges for it.