Predatory Pricing

Predatory pricing is a strategic business practice where a company deliberately sets the prices of its goods or services low with the intent to eliminate or significantly weaken competition. Once competitors are driven out of the market, the company can then raise prices to recoup losses. This practice is often regarded as anti-competitive and can lead to monopolistic behavior, which is why it is illegal in many jurisdictions.

Definition

Predatory pricing is defined as the strategic act of setting prices extremely low to eliminate competition from the market. The pricing is usually set below the cost of production, making it unsustainable for smaller competitors who cannot afford to continue operating at such a loss. Once the competition is eliminated, the company that engaged in predatory pricing can raise prices, often above the market level, to regain any lost revenue and then some.

Predatory pricing can be complex to prove legally, as it requires showing not only that the prices were set below cost but also that there was an intent to eliminate competition and that there is a reasonable likelihood that the company will recoup the losses suffered during the period of low pricing.

Example

One of the most cited examples of predatory pricing involves large retail chains, like Walmart or Amazon, who have been accused of using their vast resources to undercut smaller, local retailers.

Walmart Example

Walmart, the global retail giant, has faced numerous accusations and legal challenges regarding predatory pricing. In the 1990s and early 2000s, several local grocery stores and small businesses across the United States claimed that Walmart was setting prices so low that these smaller stores could not compete. The strategy, they argued, was intended to drive them out of business, allowing Walmart to raise prices once they were the only retailer left standing.

More information: Walmart Corporate

Amazon Example

Another recent and prominent example is Amazon. Amazon has been accused of using predatory pricing in several areas, including books and consumer electronics. Smaller bookstores and electronic retailers have complained that they cannot compete with the artificially low prices Amazon sets, which forces them out of the market. Evidence has suggested that Amazon uses data and advanced algorithms to precisely price items, often below cost.

More information: Amazon About

Why It’s Used

Predatory pricing is used primarily for:

1. Market Domination: To eliminate competitors and increase market share.
2. Entry Deterrence: To deter new entrants into the market by making it unprofitable for them to compete.
3. Long-term Profitability: To establish a monopoly or dominant position that allows the company to set higher prices in the future, leading to higher long-term profitability.

Market Domination

When a company drives competitors out of the market, it often gains significant market power, allowing it to dictate prices and terms. The elimination of competition helps the company establish itself as the primary or sole provider of certain goods or services, giving it significant control over the market.

Entry Deterrence

Predatory pricing can act as a barrier to entry for new firms. If a market is dominated by a company willing to set unsustainable low prices to thwart competition, potential new entrants may decide that the risk and cost of entering the market are too high, thereby preventing any new competition.

Long-term Profitability

While the company incurs short-term losses during the predatory pricing phase, the expectation is that, after removing competitors, the company can raise prices significantly to recoup losses and enjoy long-term profitability. Without competition, the company can often operate more efficiently and set higher margins on their products or services.

Legal and Economic Perspectives

Legal Challenges

Predatory pricing is illegal in many countries, including the United States and European Union, under anti-trust and competition laws because of its potential to create monopolies and harm consumers. Various legal tests and economic analyses are employed to identify and take action against predatory pricing practices.

• The Areeda-Turner Test: This test, developed by antitrust scholars Phillip Areeda and Donald Turner, states that pricing below average variable cost should be considered predatory, as it assumes no rational firm would price below this level unless intending to eliminate competition.
• Recoupment Test: Courts often look for evidence that the firm engaging in predatory pricing would be able to recoup its losses through higher prices once the competition is eliminated.

Economic Implications

Economically, predatory pricing can lead to a less competitive market structure, higher prices for consumers in the long run, and a reduction in innovation and product variety. A monopolized market tends to invest less in innovation compared to a competitive market where firms continuously strive to improve their offerings to attract customers.

Conclusion

Predatory pricing is a contentious and complex strategy used by companies to dominate markets, deter new entrants, and eventually reap higher long-term profits. While highly risky and potentially illegal, this strategy can fundamentally alter the competitive landscape of an industry. Understanding predatory pricing, its uses, consequences, and the legal frameworks around it is crucial for policymakers, businesses, and consumers to ensure fair competition and market health.