What is predatory pricing: Examples, definition & when is it illegal?
ProfitWell Feb 28 2022
A strategic pricing strategy is one of the best ways to increase your company's sales growth. By lowering your prices by the right amount, you can boost your chances of achieving marketing penetration and help your company become competitive in a crowded field.
However, there's a point where competitive pricing goes too far and starts to become predatory. It can be hard to distinguish between highly competitive pricing and illegal predatory pricing. In this post, we'll take a look at how you tell the difference and help you ensure that your company's pricing remains legal.
1. What is predatory pricing?
2. What does predatory pricing involve?
3. Is predatory pricing illegal in the U.S.?
4. The effects of predatory pricing
5. Examples of predatory pricing
6. When pricing becomes predatory
7. ProfitWell’s position on predatory pricing
8. Predatory pricing FAQs
What is predatory pricing?
Predatory pricing is a pricing strategy that relies on undercutting the competition long enough to force them out of the market. By setting prices below costs, other suppliers are unable to compete and have no choice but to exit the market. The company engaging in predatory pricing must take a loss during the predatory phase, but later raises prices when the competition is thinned. With enough capital to sustain predatory pricing, a company can end up with a monopoly on the market for a lengthy period of time.
What does predatory pricing involve?
Because predatory pricing relies on pricing products low enough to force other competitors out of the market, it is not a long-term pricing strategy. Instead, a company engaging in predatory pricing will break the strategy into two separate phases: one that damages the competition and another that takes advantage of the weakened competitive field.
- Stage 1: Predation - As long as a company can afford initial losses, they can lower their prices beyond what's financially stable. This will put the competition in a position where they must choose to take losses themselves or exit the market. With this strategy, large companies can often force smaller competitors out completely and prevent new competition from getting a foothold.
- Stage 2: Recoupment - When the competition has been sufficiently thinned, the predation phase ends and prices are raised back to normal levels. The goal is to reduce competition enough that the profit made during this phase makes up for the predation phase's losses. However, with market dynamics restored, remaining competitors and new entrants once again become a threat.
Is predatory pricing illegal in the U.S.?
The United States has a long history of legislation against monopolistic behavior. Because predatory pricing is designed to drive other competitors out of the market, it is typically viewed as an attempt to gain an illegal monopoly. Antitrust laws are designed to preserve market competition and minimize monopoly power. To that end, most forms of predatory pricing are illegal.
The difficulty when enforcing these laws comes from the fact that, in order to be illegal, the goal of the pricing must be to force competitors out of the market. While this is the goal of predatory pricing, it's hard to prove intent and easy for companies using predatory pricing to claim some other reason for the low prices.
Legitimate pricing strategies, such as penetration pricing, involve temporarily lowering prices to gain a foothold in the market. These strategies are not illegal because they are not long-term strategies and are rarely intended to operate at a deliberate loss.
The effects of predatory pricing
Predatory pricing has short-term positive benefits for customers in the form of ultra-low prices. The company engaging in predatory pricing will enjoy a short-term benefit of having a reduced competitive field. However, in the long run, predatory pricing does serious harm to the state of the market.
Short-term effects of predatory pricing
- Buyer's market - Companies that can afford to will finance a loss and lower prices in an attempt to remain in the market. During this initial period, customers have ultra-low prices and a nice selection of competitors to choose from. Other competitors may decide they can't compete on price and make improvements to the quality of their products instead.
- Reduced profit - Selling a product at a loss reduces profit across the whole market. Companies that can't afford the sustained loss will lose both money and customers to their lower-priced competitors.
Long-term effects of predatory pricing
- Monopoly - If the company employing predatory pricing is able to take losses for long enough and avoid regulatory action, all major competitors will have exited the market. With no meaningful competition, innovation will slow and product quality will suffer.
- Price increase - Buyers will no longer benefit from ultra-low prices as the predatory pricing period ends and the recovery phase begins. In order to realize a profit from the initial loss, the company may take advantage of its newfound monopolistic position to raise prices far higher than the market would have otherwise sustained.
Examples of predatory pricing
Predatory pricing is nothing new. Even before Aristotle first coined the term "monopoly," companies all over the world have practiced predatory pricing. Let's look at some examples to find out how the initial benefits of predatory pricing inevitably turn into drawbacks.
The Walmart/Target drug war
A prime example of predatory pricing tactics between two large franchises can be seen in the prescription drug price war between Walmart and Target in Minnesota.
Walmart, seeking to undercut the competition, initially began offering certain prescription drugs at well below their price floor. Set by the government, a price floor is the lowest price that goods or commodities can be legally sold based on the minimum cost at which turning a profit is still possible. Target, looking not to be undercut, matched these drug price cuts. However, Minnesota state law forbids the sale of drugs below their stated cost and limited the discount thus putting an end to the price war.
The Darlington bus war
Sometimes, businesses are willing to price so low that they offer their product or service for free, as seen in the Darlington Bus War. Following the deregulation of buses in 1986 in the United Kingdom, a number of private companies began to compete over the demand for public transport. One company, Busways, began offering free rides to put its rival DTC out of business, with the intent of cultivating a monopoly. A commission called Busways' actions "predatory, deplorable and against the public interest."
DTC was indeed put out of business, and Busways was then acquired by an even larger company, Stagecoach. However, Brian Souter, the chairman of Stagecoach, later admitted that the negative impact of the company's predatory strategy had outweighed the financial gains made by monopolizing the Darlington area.
Herbert Dow, the monopoly breaker
The name Herbert Dow might not sound familiar, but his company, Dow Chemical, is a household name. However, when it was first getting off the ground, the fledgling company was faced with a dilemma. Dow had created a process to separate bromine from brine. While he was able to sell competitively in the United States, a German cartel had a monopoly on the European market. This cartel had fixed the price of bromine at 49 cents per pound. The German manufacturers made it very clear that if any American tried to sell in their market, they'd flood America with cheap bromine and run the competitor out of business.
Strapped for cash, Dow had no choice but to sell in Europe, undercutting the cartel and selling his bromine for 36 cents per pound. His response to the German attempt at predatory pricing serves as a cautionary tale to those considering the strategy. The Germans made good on their threat, flooding America with bromine for 15 cents per pound. Rather than fold, Herbert bought as much of the 15-cent bromine as he could. He then sold the bromine in Europe for 26 cents per pound, undercutting the Germans with their own product and profiting from their losses.
Air Canada's special fares
In response to smaller competitors CanJet and WestJet moving onto some of its routes, Air Canada engaged in what the Canadian government called predatory pricing. The case shows how companies using predatory pricing can claim their lower prices are above board. The smaller airlines are the cheap no-frills type that offer rock-bottom pricing by cutting back on amenities. For routes they share with the smaller airlines, Air Canada lowered their $600 tickets to the under $100 charged by the budget airlines.
Because they were charging the same price, Air Canada argued that they were merely price matching and there was nothing foul going on. The government disagreed, arguing that selling premium tickets at budget prices would likely force CanJet and WestJet to abandon the routes, and that the larger airline would return to their premium prices when that happened.
Aberdeen Journals predatory pricing campaign
In 1996, newspaper publisher Aberdeen Journals faced new competition in the form of the upstart Aberdeen & District Independent. The larger publisher initially tried to shut down the launch of the Independent with a legal challenge, but failed to do so. In a further effort to squeeze the Independent out of the market, Aberdeen Journals began offering free advertisements in exchange for a promise from advertisers that they wouldn't buy space from other newspapers.
The publishers of the Independent complained, and Aberdeen Journals assured the government that it would cease the activity. However, it then began selling advertisements in its newspapers at a loss. The Independent complained again, and the government sided with the smaller publisher. Aberdeen Journals faced a heavy fine for illegal pricing.
Amazon predatory pricing
Amazon has long chosen to forego profits and instead focus on casting its net as wide as possible. Once only a bookseller, the company now competes in a growing number of industries. Pricing without regard to profit has long resulted in the company being accused of predatory pricing. Just recently, politicians have accused the tech giant of selling its smart speakers at a loss in order to price other providers in the space out of the market. Amazon denies the claim.
Perhaps the biggest proof of Amazon's predatory pricing comes from its reaction to Diapers.com. Amazon responded to the threat in the diaper space by offering prices so low that Diapers.com couldn't compete. The smaller company was eventually forced to accept a merger deal and become part of Amazon. After the merger, Amazon stopped taking new applicants into the Amazon Mom program that had forced Diapers.com's hand. Emails later revealed that the pricing strategy was intentional.
When pricing becomes predatory
Just like business ethics, aggressive marketplace competition can be a good thing. When prices are lowered, other companies must either lower prices to match or increase the quality of their product. This dynamic creates a steady stream of innovation that offers customers a nice selection of products that are neatly suited to their needs and budgets.
However, there's a difference between competitive pricing and predatory pricing. Once prices drop below cost and stay there for a sustained period of time for the express purpose of driving competitors out of the market, it ceases to be competitive. At that point, it's just predatory.
ProfitWell's position on predatory pricing
Predatory pricing may seem like a good idea to companies that can afford to do it. In reality, though, it rarely is. As we've seen from the high-profile examples, it usually doesn't work out the way the offender intends. Instead, predatory pricing hurts everyone involved. Customers are left with few choices and higher prices, competitors are driven out of business, and the company doing the predation puts itself at significant risk of legal action or losses that fail to thin the field.
It's a far better idea for companies to find a price that operates within the realm of the law and still allows for growth levers that help it realize or exceed financial goals. ProfitWell's Price Intelligently service leverages ProfitWell's years of experience analyzing prices along with our extensive market research to help your company find the pricing strategy and structures that will bring you the most profit.
Predatory pricing FAQs
How does predatory pricing affect markets?
Initially, customers will benefit from ultra-low pricing. They'll also often have several options to choose from as competitors try to lower prices and ride out the losses. However, as competitors fall and the company using predatory pricing gains monopoly power, prices rise and quality suffers due to lack of competition.
How does predatory pricing hurt competition?
Because pricing is set below cost, the only competitors that are able to remain in the market are those able to either take the losses until the predatory pricing is over or those that can significantly improve the quality of their product to justify higher prices.
What is the difference between predatory pricing and competitive pricing?
Like predatory pricing, competitive pricing involves lowering prices to gain an advantage in the market. However, competitive pricing doesn't operate at a loss. This means that other companies in the market are not forced out of the market.
What is the difference between predatory pricing and limit pricing?
Similar to predatory pricing, limit pricing involves lowering prices to a level that prevents new competitors from entering the market. However, it relies on a large company's economy of scale to offer its cheaper prices. The company employing it never operates at a loss, and existing competitors are able to more easily compete than with predatory pricing.
Subscription software helping you achieve faster recurring revenue growth.