Key Takeaways
- Prices set below cost to eliminate rivals.
- Used by dominant firms with deep pockets.
- Followed by price hikes to recoup losses.
- Illegal under many antitrust laws.
What is Predatory Pricing: Definition, Example, and Why It's Used?
Predatory pricing is a strategy where a dominant company deliberately sets prices below its costs to eliminate competitors and gain market power, planning to raise prices later for higher profits. This aggressive pricing tactic requires substantial financial resources to sustain losses until rivals exit the market.
Often confused with promotional pricing, predatory pricing focuses on long-term market dominance rather than short-term sales boosts. Understanding this practice is crucial when analyzing competitive behavior in industries such as the Delta airline market or other concentrated sectors.
Key Characteristics
Predatory pricing has distinct traits that separate it from normal competition:
- Below-cost pricing: Prices are set below average variable or total costs to inflict losses on competitors.
- Intent to dominate: The goal is to force rivals out or deter new entrants, not just gain market share.
- Temporary low prices: Losses are accepted short-term with plans to recoup through later price hikes.
- Requires market power: Only financially strong firms can sustain losses long enough to succeed.
- Barriers to entry: Signals to potential entrants that market share defense is aggressive, limiting competition.
How It Works
Predatory pricing operates in two main stages. First, the firm cuts prices below cost, sacrificing short-term profits to outlast smaller competitors who lack sufficient capital. This "predation stage" drives rivals out of the market or discourages new entrants.
Next, in the "recoupment stage," the dominant firm raises prices to monopoly levels to recover losses and earn supernormal profits. Success depends on maintaining barriers to entry and controlling the market long enough to capitalize on higher prices. Variations include tactics like "signal jamming," where firms disrupt competitors' market testing with aggressive discounts.
Examples and Use Cases
Predatory pricing has been documented in various industries where market power is concentrated and competition intense:
- Airlines: Delta and other major carriers have faced scrutiny for pricing strategies aimed at deterring low-cost entrants.
- Bus transport: The Darlington Bus Wars saw Busways use free rides and higher wages to push out Darlington Transport Company, illustrating losses used to eliminate competition.
- Stock market context: Investors interested in stable sectors might explore best large-cap stocks to avoid risks associated with aggressive pricing battles.
Important Considerations
While predatory pricing can create monopolies and harm consumers via eventual price hikes, it is difficult to prove legally due to its resemblance to competitive pricing. Regulators require evidence of below-cost pricing, intent, and likelihood of recoupment to take action. Understanding concepts like labor market dynamics and racketeering laws can provide broader context for antitrust implications.
As a practical takeaway, companies should assess whether aggressive price cuts serve long-term strategic goals or risk triggering regulatory scrutiny and damaging reputation. For investors, awareness of these practices is important when evaluating companies in concentrated industries or volatile markets such as those highlighted in the best growth stocks guide.
Final Words
Predatory pricing enables dominant firms to eliminate competition through temporary losses, aiming for long-term monopoly profits. Monitor market pricing carefully and assess whether below-cost offers are sustainable or a strategic threat to your business.
Frequently Asked Questions
Predatory pricing is a strategy where a dominant firm sets prices below its costs to drive competitors out of the market. It involves a two-stage process: first, the firm incurs short-term losses to eliminate rivals, then raises prices to recoup those losses once it gains monopoly power.
Companies use predatory pricing to force competitors out, deter new entrants, and build barriers to entry. The ultimate goal is to create a monopoly or dominant market position that allows them to increase prices and earn higher long-term profits.
A notable example is the Darlington Bus Wars in 1994, where Stagecoach-owned Busways offered free rides to attract customers from Darlington Transport Company. This caused the latter to collapse, enabling Busways to establish a local monopoly and raise fares.
Predatory pricing aims to eliminate competitors by pricing below cost for an extended period, while promotional pricing is a temporary strategy to boost short-term sales. Predatory pricing focuses on long-term market dominance, whereas promotions are short-lived and aimed at increasing customer interest.
Predatory pricing often violates antitrust laws like the Sherman Act, but proving it is challenging. Courts require evidence of below-cost pricing, harm to competition, and the ability to recoup losses, making legal cases complex and rare.
Only firms with significant market power and deep financial resources can sustain the short-term losses needed for predatory pricing. Smaller competitors usually cannot afford such losses, making them vulnerable to this strategy.
While consumers may benefit from low prices initially, predatory pricing often leads to reduced competition and higher prices later. This harms consumer choice and results in monopoly pricing once rivals are driven out.
