What is Predatory Pricing?

Predatory pricing is the nefarious act of intentionally setting the price of products or services unrealistically low. Although it may sound counter-intuitive at first, the intention behind it is to cut out competition.

By introducing prices that don’t logically correspond to market and actual value, the companies in question are, in theory, able to create a monopoly in the given industry. However, since the prices don’t correspond to the market in question, the monopoly is created under false pretences, essentially duping customers and unfairly affecting competitors.

Unfortunately, predatory pricing is considered not only unethical, but in most countries around the world, it’s actually illegal. However, because the very concept of pricing cannot be totally black and white in terms of determining what is and isn’t fair and reasonable, the process of policing predatory pricing for the purpose of upholding antitrust laws and more can be very difficult.

Thus, the reality of the business world is that predatory pricing is still used by some as a strategy for success, as companies attempt to slip below the radar and operate only just within the confines of the law in an attempt to escape punishment.

Predatory pricing can be damaging to not only specific businesses whose operations are affected by unfair practices, but to entire industries too, presenting competition and the natural growth and development of an industry.

 

Predatory Pricing as a Strategy

 

So, how exactly does predatory pricing work?

In the most basic sense, the business in question starts off by monitoring market pricing and setting a price for the product or service in question that is significantly lower than the norm across the board. It’s the kind of price that goes beyond a mere bargain.

Normally, consumers participate in a market that is competitive, with several businesses offering similar products or services at comparable prices, allowing consumers to make decisions based on things like quality, customer service and more. Businesses are incentivised to provide good products and services in order to remain competitive – if they don’t, they’ll lose business.

What you have, essentially, is a healthy, self-sustaining competitive market with businesses inadvertently keeping each other in check and ultimately maintaining high levels of quality.

Predatory pricing throws off this balance.

Essentially, one business will suddenly lower the price of a product or service far below the market standard, making it significantly cheaper than what’s available from competitors. For instance, if companies X, Y and Z sell a loaf of bread for GBP 2, company W may suddenly drop the price of a loaf of bread from GBP 2 to 20 GBP pence.

By making the price of a loaf of bread 10 times cheaper than normal, company W is setting an unrealistic and “unnatural” price in terms of the natural ebbs and flows of the market. Naturally, the initial reaction of customers is to capitalise on the bargain and buy the cheaper bread, essentially stealing, so to speak, customers away from competitors.

Ultimately, setting the price of a loaf of bread at 10 times less than normal doesn’t correspond to relevant costs and profit margins – it’s not a sustainable price and put simply, it’s not a logical or profitable pricing structure. Thus, companies X, Y and Z simply can’t compete – dropping their prices anywhere near those of company W would not be profitable.

Essentially, what ends up happening is competitors aren’t able to compete, they’re pushed out of the market and company W has a monopoly on the bread market.

Unfortunately for customers, the incentive to maintain these wildly low prices, or even generally competitive pricing, is gone. They can do just about whatever they like since consumers now have no choice but to buy their goods and services.

Predatory pricing results in competitors being pushed out of the market and potentially going out of business, employees at said businesses losing their jobs, consumers paying ridiculously high prices and employees of predatory companies suffering from low wages as the competition that normally keeps wages at competitive rates is gone.

 

 

The Effects of Predatory Pricing

 

Immediately, the first ones to be negatively affected by predatory pricing are competitors within the industry, as they end up getting pushed out and in some cases, they’re forced to close shop completely.

Next in line to be negatively affected by predatory pricing is consumers. Initially, they may benefit from questionably low prices, but once the company in question has achieved a monopoly within the market, consumers are subjected to prices that return to normal and sometimes – often – end up being even higher than before.

But, it’s not only about prices being raised once again. Consumers are also left with no choice, which means they’re forced to support the monopolistic company.

It certainly is possible that at this point, previous competitors who managed to stay afloat throughout the process as well as brand new businesses, may enter and re-enter the market respectively. If this does happen, it’s possible that things may naturally return to some kind of normalcy.

However, if the monopoly created by the predatory company has grown past a certain point, it may not be possible for the market to go back to normal on its own. Indeed, it simply won’t be feasible or worth it for new businesses to emerge, creating a permanent monopoly in the market in question.

Unless, of course, regulatory authorities step in.

 

The Legalities of Predatory Pricing 

 

Predatory pricing is not only frowned upon, it’s actually illegal in most parts of the world, although the specifics of what is and isn’t allowed, including details regarding pricing thresholds and more, may differ from one location or market to the next.

However, as much as the practice of predatory pricing is illegal in theory, it can be difficult to prove and prosecute.

Dropping prices, in itself, isn’t necessarily always a problem. It’s totally fair and legal to put products on sale, for instance, and if a company has found legitimate ways to cut manufacturing and other costs, then dropping prices accordingly is reasonable.

The problem ends up being that it can be difficult to discern the difference between the fair and appropriate act of dropping prices as opposed to ill-intentioned, illegal predatory pricing schemes.

Different countries prosecute it in varying ways. For instance, in the United Kingdom, predatory pricing is prohibited under the Competition Act of 1988, and in the United States, the Federal Trade Commission (FTC) take the lead on anti-competitive prosecutions.

Of course, in addition to specific national laws, businesses are also required to adhere to broader antitrust laws enforced by the European Union, for instance. Their job is to regulate and encourage competition across industries by intentionally limiting the power of any single organisation to prevent the development of monopolies, ultimately protecting consumers and the efficacy of natural industry competition more generally.

Despite the overwhelming intention to prevent occurrences of predatory pricing, the challenges in controlling it go beyond merely identifying companies doing it. Prosecuting companies for predatory pricing can be incredibly difficult.

For example, in the US, the Department of Justice has set a high bar with high expectations in terms of the burden of proof, requiring that prosecutors are able to show not only intention but proof that there is, in fact, a serious probability of a predatory pricing strategy being successful and eventually resulting in a monopoly. Furthermore, one of the qualifying criteria in the US is that prices need to be not only very low, but specifically, they must be below the seller’s cost price.

These extensive and complicated regulations regarding what businesses can and can’t do in terms of predatory pricing, as well as how it can and can’t be prosecuted, make for a lot of uncertainty.

 

Predatory Pricing in the Real World 

 

The good news, however, is that while it may be relatively difficult to catch and prosecute businesses that intentionally engage in predatory pricing schemes, it’s also a difficult thing to do and get right in the first place.

It may sound like a good strategy for outsiders (aside from the legal implications, of course), but the reality of actually being able to implement a strategy like this isn’t as simple. In fact, it can be incredibly risky, which is why it’s not a common thing for businesses to attempt.

Why is it risky?

Well, the whole strategy is centred on the idea of dropping prices below costs which, at the most basic level, means that the business is spending more to produce a product, for instance, than it’s getting in return, which results in a loss.

The bigger picture is that this is only intended to be a short-term reality, keeping prices super low until all other competitors can no longer survive financially. However, the problem is that it’s also difficult for the company enacting the predatory pricing to survive such low pricing. At the end of the day, it becomes a fight between the predatory company and its competitors to see who can survive the longest.

If the business setting the predatory prices has the resources to survive the loss of profits, they’ll be able to successfully push competitors out of the market and form a monopoly.

However, if their competitors end up being stronger than expected, whether that’s in terms of strategy or financial means, the predatory company may fail to create a monopoly, leading them to either return to ordinary pricing or even go under themselves.

Ultimately, predatory pricing schemes are not only illegal, but they’re also risky for companies to implement, which is why it’s not something that necessarily happens very often.