predatory-pricing

What Is Predatory Pricing? Predatory Pricing In A Nutshell

Predatory pricing is the act of setting prices low to eliminate competition. Industry dominant firms use predatory pricing to undercut the prices of their competitors to the point where they are making a loss in the short term. Predatory prices help incumbents keep a monopolistic position, by forcing new entrants out of the market.

Understanding predatory pricing

The ultimate goal of predatory pricing is to force competitors out of the market since they will not be able to compete with the dominant firm without themselves making a loss.

Once the competition has been eliminated, the dominant firm raises its prices to recoup its losses. 

The practice of predatory pricing often results in the formation of monopolies since the already dominant firm increases its market share further once competitors have been forced out. This also creates barriers to entry for new businesses.

Short and long-term effects of predatory pricing

What are the short and long-term effects of predatory pricing?

Short-term effects

In the short term, consumers may benefit from low prices as the dominant firm undercuts its competitors. 

For companies, however, profitability declines as competitors undercut each other to attract new business.

In this so-called “race to the bottom”, only one or two companies will survive and reap the rewards of increased market share. 

Long-term effects

Once competitors have been forced out of the market, the dominant firm can raise prices and recover lost profits. 

Since the consumer is more averse to purchasing as prices rise, the dominant firm will find that price appreciation is most effective on inelastic goods such as gasoline, water, consumer electronics, rail tickets, and cigarettes. 

Is predatory pricing legal?

Predatory pricing is illegal in many countries because it contravenes competition laws and causes consumer harm. 

A pricing strategy is considered predatory if it is implemented to price competitors out of the market.

This intent may be difficult to prove because a company could claim to be lowering its prices for some other reason.

Exacerbating this difficulty is the fact that, at least initially, predatory pricing appears similar to healthy market competition.

Nevertheless, it is important to understand that the act of undercutting a competitor in isolation is not indicative of predatory pricing – regardless of the size or market dominance of the company in question.

For pricing to be predatory, there must be sustained very low pricing, an anti-competitive purpose, and substantial market power.

Predatory pricing examples

Let’s now take a look at some predatory pricing examples:

Walmart and Target

In the U.S. state of Minnesota, Walmart and Target engaged in a prescription drug price war.

To undercut the competition, Walmart started selling prescription drugs well below the price floor, which is the lowest price a good can be sold for to make a profit.

Target then matched Walmart’s prices before the Minnesota state authorities stepped in and forbade the companies from selling prescription drugs below the floor price.

The Darlington Bus War

When the bus system was deregulated in the United Kingdom in 1986, several private companies began competing with established public transport operators.

One such company, Busways, offered free rides to consumers to put rival DTC out of business.

A commission formed to investigate the matter said the company’s actions were “predatory, deplorable and against the public interest.

Air Canada

In 2001, the Canadian airline company was alleged to have engaged in predatory pricing to force two smaller operators out of the market.

Representatives from WestJet and CanJet claimed Air Canada was offering $99 fares on multiple routes where the normal fare was $600.

Despite receiving cease-and-desist orders from the Competition Bureau in the past, Air Canada explained it was simply matching prices in this case and not undertaking predatory pricing.

Key takeaways

  • Predatory pricing is the act of setting prices low to eliminate the competition.
  • In the short-term, predatory pricing creates a buyer’s market where consumers have access to low prices. In the long-term, monopolistic companies recoup their initial losses by forcing consumers to pay higher prices for inelastic goods.
  • For pricing to be predatory, there must be sustained very low pricing, an anti-competitive purpose, and substantial market power. Nevertheless, it can be difficult to prove since the act of undercutting prices is not indicative of predatory pricing and may instead be an aspect of healthy market competition.

Read Next: Pricing Strategy.

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Revenue Modeling

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Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall business model.

Pricing Strategies

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A pricing strategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long term financial sustainability to build a solid business model.

Dynamic Pricing

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Price Sensitivity

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Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Elasticity

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Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

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Productized services are services that are sold with clearly defined parameters and pricing. In short, that is about taking any product and transforming it into a service. This trend has been strong as the subscription-based economy developed.

Menu Costs

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Price Floor

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A price floor is a control placed on a good, service, or commodity to stop its price from falling below a certain limit. Therefore, a price floor is the lowest legal price a good, service, or commodity can sell for in the market. One of the best-known examples of a price floor is the minimum wage, a control set by the government to ensure employees receive an income that affords them a basic standard of living.

Predatory Pricing

predatory-pricing
Predatory pricing is the act of setting prices low to eliminate competition. Industry dominant firms use predatory pricing to undercut the prices of their competitors to the point where they are making a loss in the short term. Predatory prices help incumbents keep a monopolistic position, by forcing new entrants out of the market.

Price Ceiling

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A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Bye-Now Effect

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The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.

Anchoring Effect

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The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.

Pricing Setter

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A price maker is a player who sets the price, independently from what the market does. The price setter is the firm with the influence, market power, and differentiation to be able to set the price for the whole market, thus charging more and yet still driving substantial sales without losing market shares.

Economies of Scale

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In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

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In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

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network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

Negative Network Effects

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