Predatory Pricing Definition
Predatory pricing means to sell the product at a very low price to harm competitors (companies that are selling competitive products). Predatory pricing generally means one competitor lowering the prices of the product at the very beginning to attract customers. It must be the case that the competitor lowers the price below the cost of the good, thus taking a loss on sales. Competitors have to lower their prices to keep up – thus bearing losses equal to or greater than the predatory pricer. When the competition breaks (going bankruptcy or other cases), the predator company increases the price and sells its product at a higher rate. It creates a monopoly for the predatory pricer.
It is important to note that the key element is the purpose of pushing competitors out of the market.
A Little More on What is Predatory Pricing
Predatory pricing is commonly known as “undercutting”. It is a tactic used by competitors in a price war. Predatory pricing is very difficult to prove. Much of the difficult concerns proving what is the cost of the good being sold to the seller. Depending on the supply chain and purchasing history, it is difficult to show that a seller is pricing a good below cost. Second, it is very difficult to demonstrate that a seller is pricing a good with the specific intent of thwarting competition and pushing competitors out of the market.
Predatory pricing can be a scheme to deal with the new companies who enter the market with the same or substitute product. The predatory pricer enjoys the benefits of being a larger more established company. The smaller competitor lacks the resources to sustain losses and maintain in competition with the predator company.
Of course, the cycle in predatory lending never ends. As the predatory pricer creates market dominance and raises prices, new competitors stand at the ready to enter the market and compete. As such, predatory pricing seeks to create a short-term competitive advantage for the predator company.
The reason that predatory pricing may be illegal regards antitrust and consumer protection laws. If the monopoly power of a company increases, then it will be harmful to the public interest. Consumers will be forced to pay higher prices for available goods based upon the lack of competition.
With that being said, predatory pricing is not always illegal. The FTC examines when predatory pricing violates the law. A company may be permitted to lower prices for a short duration or give discounts that result in losses. This is can be part of a valid competitive tactic if the purpose of the pricing is not to push competitors out of business. For example, a business may undertake this strategy to increase brand awareness, create loyal customers, or to increase exposure for other products or services that it sells.
References for Predatory Pricing
Academic Research on Predatory Pricing
Predatory pricing and related practices under Section 2 of the Sherman Act, J. Reprints Antitrust L. & Econ., 6, 219. A company minimizes its prices in order to diminish the competition with other companies who are selling the same product in the market. Or the company want to stop the new company from stepping in the business. Sherman Act embargoes this practice. A dearth of economic analysis identifies the law on predatory pricing. Professor Areeda and Turner inspect the predatory pricing crime in respect of economic underpinnings. The professors analyze how the company’s price and its costs are related to each other. The purpose is to differentiate between the competitive prices and the predatory pricing.
Games of perfect information, predatory pricing and the chain-store paradox, Rosenthal, R. W. (1981). Journal of Economic theory, 25(1), 92-100. Reinhard Selten discusses the situation that involves the predatory pricing monopoly. In a chain store game, the decision analytic idea is used. That explains more realistically instead of the Nash equilibrium concept.
Predatory pricing revisited, McGee, J. S. (1980). The Journal of Law and Economics, 23(2), 289-330. In this paper, the author describes the predatory pricing methodology in the previous as well as the extended context.
Predatory pricing: A strategic and welfare analysis, Williamson, O. E. (1977). The Yale Law Journal, 87(2), 284-340. This research elaborates the predatory pricing model and presents a complete analysis with respect to the welfare and strategic point of view.
A framework for analyzing predatory pricing policy, Joskow, P. L., & Klevorick, A. K. (1979). The Yale Law Journal, 89(2), 213-270. Many scholars and professors including Posner, Bork, Baumal, Scherer, Areeda and Turner, and Williamson have discussed predatory pricing problem. Sherman Act and FTC act suggest different rules that played a vital role. Despite the fact that numerous scholars have put predatory pricing problem into consideration, no proper method is available for getting out of this problem that predatory pricing causes the deterioration of competitor firms.
Predatory pricing and the Sherman Act: A comment, Sherer, F. M. (1979). J. Reprints Antitrust L. & Econ., 10, 41. This paper explains the concepts of predatory pricing in the perspective of the Sherman Act and the author gives his suggestions on it.
Predatory pricing: Strategic theory and legal policy, Bolton, P., Brodley, J. F., & Riordan, M. H. (1999). Geo. LJ, 88, 2239. This research suggests legal rules on how the predatory pricing can be put into a schematic analysis. The Supreme Court’s decision emphasizes the strategic analysis of predatory pricing. Now it has become a challenge to develop legal rules. When there is a dangerous effect of predatory pricing in the market i.e. the other firms face the difficulties to set up their business and compete in the market. When it is necessary to lower the prices to get dynamic efficiencies, then it would be allowed to do predation.
The learning curve, market dominance, and predatory pricing, Cabral, L. M., & Riordan, M. H. (1994). Econometrica: Journal of the Econometric Society, 1115-1140. In the market where two companies dominate the market, a company sells the product to the numerous customers with undetermined demands. In the Increasing Dominance (ID), the ruling company has a greater possibility to win the upcoming sale. IID is that as the possibility of winning the next sale for a company increases, length of its lead becomes greater. The discount element is greater or smaller for ID and IID. In the two-step learning, after selling two products, a company reaches the bottom of its learning curve.
Quasi-permanence of price reductions: A policy for prevention of predatory pricing, Baumol, W. J. (1979). The Yale Law Journal, 89(1), 1-26. This study focuses on the Quasi-Permanence of the price minimization. The writer presents a strategy to control the predatory pricing.
Predatory pricing and the acquisition cost of competitors, Burns, M. R. (1986). Journal of Political Economy, 94(2), 266-296. This research paper examines whether the predation causes effectiveness or it lowers the competition with other competitors. A deviant of Litzenberger Rao model determines the American Tobacco company purchased expenditures for forty-three competitors. The predatory pricing reduced the acquisition costs of the tobacco and the competitors sold out their products with ease. It is concluded that this supports predatory pricing and considers it a systematic and strategic business analysis.
Predatory pricing: Competing economic theories and the evolution of legal standards, Brodley, J. F., & Hay, G. A. (1980). Cornell L. Rev., 66, 738. This article investigates the various economic concepts of predatory pricing. It enables the reader to employ these concepts in legal analysis. Theoretically, it challenges courts when they put an effort to issue legal strategy on unresolved economic theory. Part 1 explains the PPD (Predatory Pricing Development) examining the theory straightforwarsly. Part 2 examines the theories of PP in practical applications. Whereas Part 3 illustrates a problem that challenges courts when they use economic concepts as the base for legal strategy.
A signaling model of predatory pricing, Roberts, J. (1986). Oxford Economic Papers, 38, 75-93. Predatory pricing includes decrement in pricing in the existence of competitors. In other cases, it deters entry of a new firm in the market or induces exit, or lowers the future results of the contestant. Predation is increased when the secret information about what’s going on in the market is revealed. No additional exit is applied relative to the full information standard. Though, this type of predation is harmful. Because it may reduce entry of new firm in the market.