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?
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.
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.”
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.
- 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.
Connected Economic Concepts
Positive and Normative Economics
Main Free Guides: