Definition
Predatory pricing is an aggressive pricing strategy used by businesses to force competitors out of the market or create barriers to entry for potential new competitors. This is done by setting prices lower than the production cost or significantly less than the market price, making it difficult for other businesses to compete. Over time, this can lead to monopolization, as competitors may be forced to exit the industry.
Key Takeaways
- Predatory pricing is a pricing strategy where a product or service is set at a very low price, intending to drive competitors out of the market or create barriers to entry for potential new competitors.
- Businesses that practice this strategy may sustain substantial losses in the short run. The goal is to capture the market entirely and then raise prices to achieve higher profits in the long-run once competitors are unable to compete.
- This practice, while potentially profitable, is generally considered anti-competitive and may raise legal issues under anti-trust laws in many jurisdictions.
Importance
Predatory pricing is a crucial concept in finance and competitive strategy as it directly impacts the dynamics of market competition.
This strategy involves setting the prices of products or services extremely low, typically below cost, to eliminate or create a barrier for competitors, hence obtaining a monopoly or dominant position in the market.
The significance of predatory pricing lies in its potential to harm both competitors and consumers.
While it can drive out existing competitors and discourage new entrants, it may also lead to higher prices for consumers in the long run once the company becomes the sole provider.
Therefore, understanding predatory pricing helps in enforcing competition laws and maintaining fair practices in the market.
Explanation
Predatory pricing is a strategy employed by businesses to achieve market dominance and knock out competition; it essentially involves setting low prices, sometimes below the cost of production, to deter new entrants and eliminate existing competition. By setting significantly low prices, a company can make it unfeasible for smaller businesses to compete within the same market, causing them to eventually drop out.
The purpose is to create a monopoly or oligopoly situation where the dominant company then has the power to dictate prices and control the market. Furthermore, predatory pricing is also used as a barrier to entry for new businesses.
It forces potential companies to reconsider entering the market as they would need to match or beat these low prices to attract customers. Established companies with substantial financial resources are best positioned to employ this strategy as they can absorb the losses stemming from reduced prices for a certain period.
Despite its potential to secure market dominance, predatory pricing is considered anti-competitive and is often regulated in many jurisdictions.
Examples of Predatory Pricing
Amazon: Amazon has been often accused of utilizing predatory pricing practices. For example, they were alleged to sell goods, particularly books and other products, well below the cost price to undercut competitors, essentially driving them out of the market or even out of business. After driving out competitors, Amazon, then, could afford to raise prices with a monopolistic control of the market.
Walmart: This mega-retailer has faced similar accusations over the years. Walmart’s strategy was to price goods lower than their competitors, forcing smaller companies to either match prices and endure losses, or lose customers to Walmart. Over time, many smaller retailers and local shops were unable to survive against this strategy and had to close, giving Walmart a dominant position in the market.
Uber: Uber had been accused of predatory pricing in multiple countries including India and the United States. In India, for instance, it was alleged that Uber lowered its fares to a level where they were drastically lower than cost prices, causing traditional taxi operators to lose business massively. It’s been alleged that they adopted this strategy to gain a rapid user-base and push out competition.
Predatory Pricing FAQ
What is predatory pricing?
Predatory pricing is a strategy where a dominant company lowers its prices to a level that is not profitable, with the aim of pushing competitors out of the market or preventing new competitors from entering the market. Once the competitors have been removed, the company can raise its prices again to levels that can generate profits.
Is predatory pricing illegal?
Yes, predatory pricing is considered illegal in many jurisdictions because it is anti-competitive in nature. It violates antitrust laws as it can result in a monopoly or dominant positioning, leading to lower competition and higher prices for consumers in the long run.
How can predatory pricing be proven?
Proving predatory pricing can be challenging due to the difficulty in differentiating between competitive low pricing and predatory pricing. However, it typically involves demonstrating that the prices are not just low but are below an appropriate measure of cost, and that there is a reasonable possibility of recouping the losses through higher prices once competitors are excluded.
What are some examples of predatory pricing?
One noted case involved the airline industry in the U.S., where American Airlines was accused of dropping their prices below cost in order to drive Vanguard Airlines and SunJet out of business. Another example comes from the retail industry, where Walmart was once accused of predatory pricing with the intention of driving smaller businesses out of the market.
Related Entrepreneurship Terms
- Price Discrimination
- Anti-Competitive Practices
- Market Dominance
- Consumer Exploitation
- Regulatory Laws
Sources for More Information
- Investopedia: A comprehensive financial education website that offers a wide array of information about different financial concepts, including predatory pricing.
- Entrepreneur: A popular publication that provides advice, insight, profiles, and guides for established and aspiring entrepreneurs worldwide, including articles about various business strategies such as predatory pricing.
- Federal Trade Commission: The official website of FTC provides regulations and guidance about business practices, which also includes predatory pricing.
- Harvard Business Review: An esteemed publication by Harvard University which provides thought leadership and deep insight into business and management practices, including predatory pricing.
