Definition & Predatory Pricing Examples | Is Predatory Pricing Illegal?
What is Predatory Pricing
Predatory Pricing refers to the practice of pricing goods or services at a low price in order to establish a competitive market position and eliminate competitors.
Predatory pricing occurs when dominant firms use lower prices to buy out smaller rivals who offer no serious competitive constraint. It works by allowing dominant firms to have significant market share, which enables them to raise prices.
The idea that predatory pricing can benefit consumers by driving prices down is supported by many economists who argue that predatory pricing can lower prices, improve quality and increase choice.
The predatory pricing theory has also been widely used as an argument against government intervention in the market. As opposed to traditional theories, which suggest that market forces would tend to allocate resources efficiently, some economists believe that such allocation can only occur if there is a competitive market condition.
Under the Competition Act, predatory pricing is generally considered to be “the act of selling products or services for unreasonably low prices with the intention that competition in these sectors will be eliminated or substantially reduced.”
Type of Predatory Pricing
Loss of Control” Type of Predatory
The “loss of control” type of predatory pricing is where the predator can buy an asset (stock, plant, research project) at a below-market price in order to keep control over it. This lowers the potential profits to be made by the asset holders.
Because investors initially expected that the price would rise, they did not respond quickly enough to prevent a price decline. When the market realizes this and reacts by selling the asset, it can lead to a very damaging collapse in stock prices immediately after acquisition.
“Loss-making” predation can also occur when a firm with a cost-based cost advantage sells its output below average variable costs for an extended period & does not immediately recoup its losses with higher future prices. It can be shown that, even if firms have rational expectations and are aware of the predator’s presence, loss-making predatory pricing will not be deterred by potential prey.
A related example would be an oil company taking control over an oilfield to raise its own production by cutting costs or raising prices. This can harm the oil industry as well as smaller players in the oil-producing business.
Merger Predatory Pricing
Predatory pricing can also take the form of a merger where a large company is trying to acquire a smaller company for its assets which has enjoyed significant success. If the larger corporation originally overpaid, they will lose money on their investment. A variant of this is when a large company acquires a smaller company to spend money now on research and development. The result is the large company also loses money.
However, the main implication is that predatory pricing will generally be more difficult to prosecute than predatory pricing, which causes a loss to the predator.
Making Profits” Predation
“Making profits” predation occurs when successful predation would require the predator to sell under its average cost as well as sell below the prices of at least some of its competitors. In the extreme, making profits, predatory pricing occurs when a firm incurs a loss from selling at a price that is above average variable cost.
There are two main ways for predation to be “making profits”:
In some circumstances, both of the above conditions may be satisfied. Although it is sometimes assumed that predation can rarely occur in equilibrium, there are examples of firms engaging in making profits predation in U.S. markets; and it is plausible that much of OPEC’s output could be consistent with such an equilibrium.
Another form of predatory pricing is known as “success-based” pricing, where it is contingent on the rival company’s failure. It refers to a situation where the predator sells goods at prices that cover variable costs but do not cover fixed costs; furthermore, this enables it to “cover losses from unsuccessful price competition in prior periods.”
Success-based pricing typically involves a firm facing strong price competition and is attempting to minimize losses. This form of predatory pricing can be distinguished from loss-making predatory pricing because the firm does not necessarily intend to cover its fixed costs; it only intends to recoup losses on prior failed attempts.
Besides, if the predator fails in the future, it will have to cover its fixed costs with average variable cost prices, making success-based pricing sustainable in the long run.
Predatory pricing can be a strategy used by firms to increase their profits. Because predatory pricing aims to reduce the price of consumer goods, it increases the firm’s profit margin. This increases overall consumer benefits and may encourage more imitation by other firms.
Predatory pricing is also a strategy used by firms to reduce their losses on past investments. It may be one of a number of strategies used by firms that are sustainable given the normal operation of competition in an industry. Others would include pricing at average costs or above-average costs and attempting to make a profit on the acquisition of the asset in question.
Firms sometimes use predatory pricing in order to gain a temporary market share to reap savings from their competitors. However, once the price war ends and the threat of losses ceases, the predator will likely be forced to reduce prices back to average variable cost as well.
If predatory pricing is sustained, both predator and prey will suffer losses. Peebles & Powell (2007) have shown that predatory pricing can lead to winners and losers in the long run. Services and manufacturing play different roles in determining which firms will be better off or worse off after being predated.
Motivations for Predatory Pricing
Many firms engage in predatory pricing for economic reasons. Predation is a way for the firm to increase its profits or reduce its losses in an effort to maximize its overall level of profits. This is related to the idea that firms with efficient costs will have the greatest profits; predatory pricing is a way that firms can exploit consumers by cutting prices below cost, allowing them to earn higher profits than they would have if they had their costs covered.
This is often the case with monopolies, who have no close substitutes; they can charge any price they choose.
The three main motivations for predatory pricing are:
- To eliminate competitors.
- To acquire market share.
- To attempt to increase market power.
Legal regulations may require that a firm has some kind of business justification when selling goods at less than average variable cost.
Is Predatory Pricing Illegal?
Predatory pricing is a practice of charging prices below the cost or average price to eliminate competition. It a form of unfair competition
Predatory pricing is not illegal. The Federal Trade Commission (FTC) has ruled on this issue and found that predatory pricing can be illegal under certain circumstances. Still, it’s not always easy to tell if the price is predatory.
The Federal Trade Commission defines predatory pricing as “a business practice whereby a company charges low prices, either for goods or services, with the intent to drive competitors out of business or create barriers to entry.”
Predatory pricing can be used as an anti-competitive tactic by monopolies and oligopolies who wish to maintain their high profits without having new rivals enter the market.
Predatory Pricing Is A Violation of Antitrust Laws
Predatory pricing is a violation of antitrust laws. Besides, it is also an illegal practice under the Federal Trade Commission Act.
In the United States, predatory pricing was first proposed as a federal antitrust standard in the context of finding out-of-market pricing below cost to be harmful to consumers.
The courts have since decided that prices below average variable cost can be considered predatory pricing if it is directed at smaller, weaker firms. In comparison, larger firms engage in normal marketing practices.
Many economists believe that predatory pricing should be illegal and should fall under anti-trust legislation. However, the cases in which companies have been reported for doing this are far and few between.
Predatory pricing is legal only when it can be proven that there is “harm” to consumers by decreasing the price, such as loss of income, loss of financial security, or a damaging effect on brand value. Other forms of predatory pricing, such as multiple pricing policies (i.e., seller offering the exact same product at different prices to various customers), are also illegal.
Predatory Pricing examples
Predatory Pricing Cases
A few well-known examples of predatory pricing include:
IBM’s foray into the personal computer market with the IBM PC, which led to a precipitous decline in the sales of the “clone” manufacturers of PCs. A study done by Terrance Odean found that buying firms with lower returns on assets and higher leverage exhibited lower rates of return and earnings growth before IBM acquired them.
Another example: The Microsoft Corporation’s antitrust case by the Department of Justice in 1998 is an example of attempted “loss of control” predatory pricing, or the inability to capture consumer demand immediately. The DOJ alleged that Microsoft was attempting to maintain its market dominance against Netscape by offering Internet Explorer free of charge while charging for Netscape Navigator and bundling it with its popular Windows operating system.
However, the United States District Court for the District of Columbia found that Microsoft’s actions were not illegal under U.S. competition law. Still, Microsoft appealed the case to the U.S. Court of Appeals for the District of Columbia Circuit in 2001 and lost in 2005 when the court upheld the lower court’s decision that Microsoft’s pricing was competitively marginal and not predatory. As a result, Netscape became a “smoke-free” monopoly and was eventually acquired by AOL.
Amazon Predatory Pricing
Amazon, the world’s largest online retailer, has been accused of predatory pricing practices by many competitors. The accusation is that Amazon prices its products below cost in order to drive out competition and then, once it does so, raise prices to a level where they can make a profit.
This practice is illegal under U.S antitrust law because it limits consumer choice and forces consumers into paying higher prices than they would otherwise have had to pay.
A recent example of this was when Amazon priced e-books below cost in order to force bookstores like Barnes & Noble out of business.
Walmart Predatory Pricing
Walmart has been accused of predatory pricing. The company is a major player in the retail industry, and its practices have received criticism for decades.
Critics argue that Walmart’s low prices are achieved by undercutting competitors’ prices to drive them out of business using predatory pricing tactics.
The company has been accused of predatory pricing on a number of occasions.
In 2008, Walmart was investigated to sell DVDs at below cost to drive out competition and then raise prices once they had eliminated all competitors from the market.
This practice is illegal under US antitrust law and can lead to fines or even jail time for executives.
Reliance Jio’s predatory pricing
Reliance Jio has been aggressively pricing its offers to provide the best value for money. Jio’s predatory pricing strategy is a threat to the telecom industry. The company has been accused of undercutting competitors by offering free voice and data services.
It also offers plans that are significantly cheaper than those offered by other telecoms. This will force its competitors to either cut prices or lose customers.
Limit Pricing Vs. Predatory Pricing
Limit pricing is a strategy in which the seller sets prices at or near their production cost so that they can make a profit on every sale.
Predatory pricing is when a company sells goods below its own costs to eliminate competition and then raises prices once it has eliminated all of its competitors.
Limit pricing is not illegal under antitrust laws because it does not harm consumers, while predatory pricing can be considered an unfair business practice.
Limit pricing is a strategy that involves setting the price of goods or services at a level high enough to discourage demand but not so high as to result in shortages.
Predatory pricing is an aggressive marketing strategy where prices are set below cost to drive out competitors and monopolize the market.
The difference between limit pricing and predatory pricing is that limit pricing sets prices low enough to avoid shortages, while predatory pricing sets prices low enough to drive out competition.
Another difference between limit pricing and predatory pricing lies in intent. While limiters want to maximize profits by setting an optimal price point for their products, predators want to eliminate competition so they can increase their profit margins.
Predatory Pricing Advantages and Disadvantages
Predatory Pricing Advantages
Predatory pricing is a non-conventional method of lowering prices in the market, especially when the product is new or poorly known by consumers before its release.
The main advantage of predatory pricing is that it can create more sales, even if the actual amount of money lost or gained is small.
A company can use predatory pricing in order to eliminate the competition. For example, if a new internet search engine is being introduced and the product is very similar to its competitors who have already been in the market for many years.
However, due to its lower price and innovative technique, it will be able to attract consumers away from competing products. Even if the product is not particularly attractive and does not have favorable user reviews or ratings on the internet, it will still attract customers who are looking for a cheaper alternative.
Predatory pricing as a Marketing Tool
Predatory pricing can be used as a marketing tool, especially when the company is new or has an excellent product.
For example, when Apple introduced its iPad in 2010 at a price of $499, the company was trying to reach as many customers as possible. This competitive pricing strategy was used to establish Apple’s product as a leader in the market at that time and against all competitors. However, due to the iPad’s limited functionality and a very high price, it could only reach a fraction of the market share.
Predatory Pricing Disadvantages
- The disadvantage is that it may have to be repeated time and time again, which can cause more economic losses than making a profit in the first place.
- It can lead to a price war among competitors, which is not good for the company. The company may be forced to sell at a loss if it cannot find new customers.
- Predatory pricing could also damage the reputation of the company.
- It can be difficult to determine the point at which prices are predatory.
- Companies may not want to invest in a product if they know it will be sold for a lower price by competitors
- Predatory pricing is illegal in many countries
- The company may be forced to sell at a loss, which can hurt its long-term profitability and sustainability