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Predatory Pricing: Definition, Example, and Why It’s Used

Definition

Predatory pricing is a competitive strategy adopted by companies where they artificially set very low prices for their products or services with the intention to force competitors out of the market or create high barriers for new entrants. It typically leads to a temporary loss for the company employing the strategy, but they aim to regain profits once competition is eliminated and they have significant market control. As it tends to lessen competition and can lead to monopolistic market conditions, it’s often a topic of concern in anti-trust cases.

Phonetic

Predatory Pricing: /ˈprɛdəˌtɔri ˈpraɪsɪŋ/Definition: /ˌdɛfɪˈnɪʃən/Example: /ɪgˈzæmpəl/And: /ænd/Why: /waɪ/It’s: /ɪts/Used: /juːzd/

Key Takeaways

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  1. Definition: Predatory pricing is a strategy employed by a company to set the price of its products or services at an extraordinarily low level, with the objective of driving competitors out of the market, or creating a barrier for new entrants. This strategy might involve short-term losses but ultimately aims for long-term advantage.
  2. Example: A hypothetical example could be of a big supermarket chain slashing the prices of its products significantly in a local area to oust smaller grocery competitors. Once the smaller stores are out of business due to unsustainable prices, the supermarket increases its prices again, gaining a monopoly in that area.
  3. Why It’s Used: Predatory pricing is used to stave off competition and establish a dominant position in the market. By undercutting the prices, an established company can deter new entrants or even eliminate smaller rivals, thereby gaining a higher market share and potentially monopolistic control. This strategy, however, is often scrutinized and can be illegal under competition law if it leads to anti-competitive practices.

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Importance

Predatory pricing is a critical business/finance term as it directly influences competition and consumer choices within a market. This term represents a strategic pricing method where a firm intentionally lowers its prices to levels below its operational costs, aiming to eliminate competitors or prevent new businesses from entering the market. Once the competition is ousted, the firm can monopolize the market, raise prices, and start recovering the losses incurred during the period of reduced cost. An example of predatory pricing could be a supermarket chain drastically reducing prices on some products to oust local grocers. While predatory pricing can trigger short-term consumer benefits, such as lower prices, its long-term effects can lead to reduced competition, limiting choices, and potentially resulting in higher prices. Therefore, understanding predatory pricing is essential for regulatory bodies to guard against monopolistic practices and maintain healthy market competition.

Explanation

Predatory pricing is a strategic pricing method employed by corporations with dominant market positions, aimed at eliminating existing competition or preventing new competitors from entering the industry. The business purpose is to create a monopolistic market environment where they are the sole providers of a particular good or service. Accomplished by setting exceptionally low prices, often below the cost of production or provision, predatory pricing intends to run competitors out of the market, as they wouldn’t be able to sustain matching the low prices without incurring substantial losses.Once the competition has been effectively incapacitated or driven out of the market, the firm then raises its prices above competitive levels to recoup previous losses and enjoy high profit margins. For instance, a large grocery chain may drastically reduce all its prices to the point that smaller grocers can’t compete. Once these competitors fold, the chain can raise its prices with little worry about competition. Predatory pricing serves both a defensive and offensive purpose in the world of economics, facilitating the creation of monopolies or the protection of existing ones. This pricing strategy, however, is considered illegal in many jurisdictions due to its destructive effect on healthy market competition and consumer welfare.

Examples

Predatory pricing is a strategy where a product or service is set at a very low price, intending to drive competitors out of the market, or create barriers for entry into the market. Once the competing businesses are eliminated, the predatory pricer raises the price significantly.1. Amazon: Amazon has often been accused of predatory pricing practices to drive out competing book retailers. They would sell books at a price significantly lower than the market rate. This led to smaller book retailers, unable to compete with the low prices, exiting the market. With fewer competitors, Amazon could then increase its prices. 2. Walmart: Walmart has a history of predatory pricing practices. They are known for entering a new market and setting prices exceptionally low. Small businesses cannot compete with these low prices and are eventually forced to close. Once the competition is wiped out, Walmart has more freedom to raise its prices.3. Uber: The ride-hailing service has also been accused of predatory pricing. Uber entered several new markets by offering rides for a cost considerably lower than traditional taxi services. As a result, many taxi companies went out of business. Once Uber established its dominance in the market, it began increasing its prices.

Frequently Asked Questions(FAQ)

What is Predatory Pricing?

Predatory pricing is a pricing strategy where a product or service is set at a very low price with the aim of driving competitors out of the market or creating barriers to entry for potential new competitors.

Can you provide an example of Predatory Pricing?

An example of predatory pricing is when a large coffee chain decides to reduce its prices substantially in order to eliminate some small local coffee shops. They can afford this because of their large scale and financial strength, and the smaller competition cannot match the reduced prices and therefore may go out of business.

Why is Predatory Pricing used in business?

Predatory pricing is often used to establish dominance in the market. By lowering the price, companies can discourage new competitors from entering the marketplace, and potentially force existing competitors out of business.

Is Predatory Pricing legal?

Predatory pricing is often viewed as anti-competitive and can be illegal in many jurisdictions. However, it can be challenging to prove a company is engaging in predatory pricing because they could argue they are simply competing on price.

What are the effects of Predatory Pricing on the market?

Predatory pricing can lead to a decrease in competition, which may allow the predatory seller to raise prices and gain higher profits in the long term. On the consumer side, while low prices can be beneficial initially, consumers may face high prices or limited choices once competition has been eliminated.

How can a business compete against Predatory Pricing?

Businesses can compete against predatory pricing by differentiating their product to create value, reducing their operating costs, building customer loyalty, or striving for legal protection if they believe that they are a victim of predatory pricing.

Is Predatory Pricing a sustainable strategy?

While predatory pricing might eliminate competitors in the short term, it’s not a sustainable strategy for long. Maintain extremely low prices can put the business under financial strain. Moreover, once the prices rise again, it could invite new competitors to enter the market.

How can Predatory Pricing be detected?

Predatory pricing can be suspected if a firm is selling a product or service below its cost price. However, establishing this can be complex, as determining the actual cost of a product or service may not be straightforward. Laws, regulations, and extensive market analysis are instrumental to confirm and take action against this strategy.

Related Finance Terms

  • Anti-Competitive Practices: Practices conducted by businesses to limit or prevent competition, predatory pricing being one of them.
  • Market Dominance: The condition in which a company becomes large enough to influence the market price, often achieved through predatory pricing.
  • Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay. Predatory pricing can increase consumer surplus in the short term.
  • Price Discrimination: It’s a pricing strategy where identical goods or services are sold at different prices by the same provider in different markets or segments, which can be linked with predatory pricing.
  • Anti-Trust Laws: Legislation enacted to prevent monopolies and promote competition. Predatory pricing can be seen as a violation of these laws.

Sources for More Information

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