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?
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.
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.
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.
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.
- 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.
- 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.
- 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.
Read Next: Pricing Strategy.
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