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.
Aspect of Predatory Pricing | Description |
---|---|
Definition | Setting low prices to eliminate competition, often practiced by dominant firms. |
Goal | Force competitors out of the market by making them operate at a loss. |
Short-Term Effects | Consumers benefit from lower prices. Companies engage in a “race to the bottom,” resulting in few surviving firms with increased market share. |
Long-Term Effects | Dominant firm raises prices after competitors exit, regaining profits. Effective on inelastic goods like gasoline, water, electronics. |
Legality | Illegal in many countries due to competition laws and harm to consumers. Proving predatory intent can be challenging. Requires sustained low pricing, anti-competitive intent, and significant market power. |
Examples | – Walmart and Target’s prescription drug price war<br> – The Darlington Bus War in the UK – Allegations against Air Canada for low fares<br> – Amazon’s e-book pricing strategies – Microsoft’s pricing of Windows OS – Uber’s ride-sharing pricing strategies |
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.
Case Studies
- Walmart and Target: In the U.S. state of Minnesota, Walmart and Target engaged in a prescription drug price war. Walmart started selling prescription drugs well below the price floor to undercut competitors, and Target matched these prices. Authorities eventually stepped in and forbade them from selling prescription drugs below the floor price.
- The Darlington Bus War: After the deregulation of the bus system in the United Kingdom in 1986, private companies competed with established public transport operators. One company, Busways, offered free rides to consumers to put the rival DTC out of business. A commission formed to investigate the matter called the company’s actions “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 that Air Canada was offering $99 fares on multiple routes where the normal fare was $600. The Competition Bureau issued cease-and-desist orders in the past, but Air Canada explained it was simply matching prices in this case and not engaging in predatory pricing.
- Amazon: Amazon has faced allegations of predatory pricing in various ways. One example is how it reportedly priced e-books very low, sometimes below cost, to gain a dominant position in the e-book market. This led to antitrust concerns and legal actions in several countries.
- Microsoft: In the late 1990s, Microsoft faced accusations of predatory pricing with its Windows operating system. It was alleged that Microsoft sold Windows licenses to computer manufacturers at such low prices that it made it difficult for competitors like Netscape to compete in the browser market. This led to a high-profile antitrust case against Microsoft.
- Uber: Uber has been accused of predatory pricing in some markets. By offering rides at prices below the actual cost, Uber aimed to drive traditional taxi services out of business and establish a monopoly in the ride-sharing industry. This strategy has faced scrutiny in multiple cities and countries.
- Predatory Pricing in Ride-Sharing: In various regions, ride-sharing companies like Uber and Lyft have been accused of using predatory pricing to gain market share. They often offer substantial discounts and subsidies to both riders and drivers, with the goal of driving traditional taxi services out of business and establishing a monopoly.
- Pharmaceutical Industry: Some pharmaceutical companies have been accused of predatory pricing for essential medications. They raise prices significantly for drugs that have limited substitutes, making them less accessible to consumers and potentially forcing competitors out of the market.
- Telecommunications Industry: Telecommunications companies have faced allegations of predatory pricing when they offer bundled services, such as phone, internet, and TV, at very low introductory prices to attract customers. Once customers are locked into contracts, prices often increase significantly.
- Retailers and Small Competitors: Large retailers, like supermarkets and big-box stores, have been accused of predatory pricing by selling certain products below cost. This can put financial pressure on smaller competitors, potentially driving them out of business.
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.
Key Highlights about Predatory Pricing:
- Introduction: Predatory pricing involves setting low prices to eliminate competition, with the aim of establishing monopolistic dominance in the market. The dominant firm undercuts competitors, forcing them to exit, and subsequently raises prices to recoup losses.
- Goal and Outcome: The primary objective of predatory pricing is to eliminate competitors by making them operate at a loss. This strategy allows the dominant firm to attain a monopolistic position and raise prices once competition is gone, creating barriers for new entrants.
- Short and Long-Term Effects:
- Short-term Effects: Consumers benefit from lower prices due to competition. However, companies’ profitability declines as they engage in a “race to the bottom” to attract customers, resulting in few surviving firms with increased market share.
- Long-term Effects: After competitors exit, the dominant firm raises prices to regain profits. Price hikes are effective for inelastic goods, such as gasoline or electronics, where consumers are less sensitive to price changes.
- Legality:
- Predatory pricing is illegal in many countries as it goes against competition laws and harms consumers.
- Proving predatory intent can be challenging, as companies may claim lower prices for other reasons.
- Sustained low pricing, anti-competitive intent, and significant market power must be present for pricing to be considered predatory.
- Examples of Predatory Pricing:
- Walmart and Target: Engaged in a prescription drug price war in Minnesota, with Walmart selling below profit thresholds and Target matching prices. Authorities intervened to prevent selling below floor price.
- Darlington Bus War: Busways offered free rides to undermine rival DTC when bus deregulation occurred in the UK.
- Air Canada: Allegedly engaged in predatory pricing by offering $99 fares to outcompete smaller operators. Debate over predatory intent and market matching.
- Key Takeaways:
- Predatory pricing involves strategically setting low prices to drive competitors out of the market.
- Short-term effects benefit consumers, but long-term effects lead to monopolistic control and higher prices for essential goods.
- Proving predatory pricing requires demonstrating sustained low prices, anti-competitive intent, and substantial market power. Undercutting alone is not necessarily indicative of predatory pricing.
Expanded Pricing Strategies Explorer
Pricing Strategy | Description | Key Insights |
---|---|---|
Cost-Plus Pricing | Markup added to production cost for profit | Ensures costs are covered and provides a predictable profit margin. |
Value-Based Pricing | Prices set based on perceived customer value | Aligns prices with what customers are willing to pay for the product or service. |
Competitive Pricing | Pricing in line with competitors or undercutting | Helps maintain competitiveness and market share. |
Dynamic Pricing | Prices adjusted based on real-time demand | Maximizes revenue by responding to changing market conditions. |
Penetration Pricing | Low initial prices to gain market share | Attracts price-sensitive customers and establishes brand presence. |
Price Skimming | High initial prices gradually lowered | Capitalizes on early adopters’ willingness to pay a premium. |
Bundle Pricing | Multiple products or services as a package | Increases the perceived value and encourages upselling. |
Psychological Pricing | Pricing strategies based on psychology | Leverages pricing cues like $9.99 instead of $10 for perceived savings. |
Freemium Pricing | Free basic version with premium paid features | Attracts a wide user base and converts some to paying customers. |
Subscription Pricing | Recurring fee for ongoing access or service | Creates predictable revenue and fosters customer loyalty. |
Skimming and Scanning | Continually adjusting prices based on market dynamics | Adapts to changing market conditions and optimizes pricing. |
Promotional Pricing | Temporarily lowering prices for promotions | Encourages short-term purchases and boosts sales volume. |
Geographic Pricing | Adjusting prices based on geographic location | Accounts for variations in cost of living and local demand. |
Anchor Pricing | High initial price as a reference point | Influences perception of value and makes other options seem more affordable. |
Odd-Even Pricing | Prices just below round numbers (e.g., $19.99) | Creates a perception of lower cost and encourages purchases. |
Loss Leader Pricing | Offering a product below cost to attract customers | Drives traffic and encourages additional purchases. |
Prestige Pricing | High prices to convey exclusivity and quality | Appeals to premium or luxury markets and enhances brand image. |
Value-Based Bundling | Combining complementary products for value | Encourages customers to buy more while receiving a perceived discount. |
Decoy Pricing | Less attractive third option to influence choice | Guides customers toward a preferred option. |
Pay What You Want (PWYW) | Customers choose the price they want to pay | Promotes customer goodwill and can lead to higher payments. |
Dynamic Bundle Pricing | Prices for bundled products based on customer choices | Tailors bundles to customer preferences. |
Segmented Pricing | Different prices for the same product by segments | Considers diverse customer groups and willingness to pay. |
Target Pricing | Prices set based on a specific target margin | Ensures profitability based on specific financial goals. |
Loss Aversion Pricing | Emphasizes potential losses averted by purchase | Encourages decision-making by highlighting potential losses. |
Membership Pricing | Exclusive pricing for members of loyalty programs | Fosters customer loyalty and membership growth. |
Seasonal Pricing | Price adjustments based on seasonal demand | Matches pricing to fluctuations in consumer behavior. |
FOMO Pricing (Fear of Missing Out) | Limited-time discounts or deals | Creates urgency and encourages purchases. |
Predatory Pricing | Low prices to deter competitors or drive them out | Strategic pricing to gain market dominance. |
Price Discrimination | Different prices to different customer segments | Capitalizes on varying willingness to pay. |
Price Lining | Different versions of a product at different prices | Catering to various customer preferences. |
Quantity Discount | Discounts for bulk or volume purchases | Encourages larger orders and repeat business. |
Early Bird Pricing | Lower prices for early adopters or advance buyers | Rewards early commitment and generates initial sales. |
Late Payment Penalties | Additional fees for late payments | Encourages timely payments and revenue collection. |
Bait-and-Switch Pricing | Attracting with a low-priced item, then upselling | Uses attractive deals to lure customers to higher-priced options. |
Group Buying Discounts | Discounts for purchases made by a group or community | Encourages collective buying and customer loyalty. |
Lease or Rent-to-Own Pricing | Lease with an option to purchase later | Provides flexibility and ownership choice for customers. |
Bid Pricing | Customers bid on products or services | Prices determined by customer demand and willingness to pay. |
Quantity Surcharge | Charging a fee for purchasing below a certain quantity | Encourages larger orders and higher sales. |
Referral Pricing | Discounts or incentives for customer referrals | Leverages word-of-mouth marketing and customer networks. |
Tiered Pricing | Multiple price levels based on features or benefits | Appeals to customers with varying needs and budgets. |
Charity Pricing | Donating a portion of sales to a charitable cause | Aligns with corporate social responsibility and attracts conscious consumers. |
Behavioral Pricing | Price adjustments based on customer behavior | Customizes pricing based on customer interactions and preferences. |
Mystery Pricing | Prices hidden until the product is added to the cart | Encourages customer engagement and commitment. |
Variable Cost Pricing | Prices adjusted based on variable production costs | Reflects cost changes and maintains profitability. |
Demand-Based Pricing | Prices set based on demand patterns and peak periods | Maximizes revenue during high-demand periods. |
Cost Leadership Pricing | Competing by offering the lowest prices in the market | Focuses on cost efficiencies and price competitiveness. |
Asset Utilization Pricing | Pricing based on the utilization of assets | Optimizes revenue for assets like rental cars or hotel rooms. |
Markup Pricing | Fixed percentage or dollar amount added as profit | Ensures consistent profit margins on products. |
Value Pricing | Premium pricing for products with unique value | Attracts customers willing to pay more for exceptional features. |
Sustainable Pricing | Pricing emphasizes environmental or ethical considerations | Appeals to conscious consumers and supports sustainability goals. |
Read Next: Pricing Strategy.
Connected Economic Concepts
Positive and Normative Economics
Main Free Guides: