Predatory pricing

What Is Predatory Pricing?

Predatory pricing is a deliberate business strategy where a company sets its prices extremely low, often below the cost of production, with the intent to eliminate or significantly weaken competition in a market. This aggressive pricing aims to drive out existing rivals and deter potential new market entry, ultimately allowing the predator to establish a monopoly or gain substantial market power. It is considered an anti-competitive practice and falls under the broader financial category of antitrust laws and competition policy. While beneficial for consumers in the short term due to lower prices, the long-term effect of successful predatory pricing can lead to reduced consumer welfare through higher prices and fewer choices once competition is suppressed.²²

History and Origin

The concept of predatory pricing gained prominence with the development of modern antitrust legislation. In the United States, the Sherman Antitrust Act of 1890 was a landmark law that prohibited monopolistic practices, including actions like predatory pricing, aimed at restraining trade.²⁰, ²¹ One of the earliest and most influential cases to tackle such practices was the 1911 Supreme Court case of Standard Oil Co. of New Jersey v. United States, which ruled against Standard Oil's aggressive pricing strategy as an attempt to monopolize the oil industry.¹⁹

Over time, economic theory and judicial interpretations have shaped the understanding and legal standards for predatory pricing. The debate often centers on distinguishing legitimate aggressive pricing strategies from truly predatory ones. The Supreme Court's 1993 decision in Brooke Group Ltd. v. Brown & Williamson Tobacco Corp. established a stringent two-part test for proving predatory pricing, requiring evidence of below-cost pricing and a reasonable probability of the predator recouping its losses through later price increases. This ruling made it significantly more challenging for plaintiffs to win predatory pricing cases.¹⁷, ¹⁸

Key Takeaways

• Predatory pricing involves intentionally setting prices below cost to eliminate competition.
• The primary goal is to achieve a monopoly or dominant market share, allowing for higher prices later.
• It is considered illegal under antitrust laws in many jurisdictions, including the U.S.
• Proving predatory pricing in court is notoriously difficult, requiring evidence of below-cost pricing and the likelihood of recoupment.
• While offering short-term benefits to consumers, successful predatory pricing can lead to reduced choice and increased prices in the long run.

Interpreting Predatory Pricing

Interpreting predatory pricing primarily involves analyzing a firm's pricing behavior in relation to its costs and the market structure. Regulators and courts look for evidence of a company deliberately incurring an economic loss by selling products or services below their cost, not merely engaging in aggressive, but legitimate, price competition. The key is the intent to eliminate or deter competitors, followed by the ability to raise prices and recover initial losses once competition is reduced.¹⁶

Consideration is given to the market conditions, such as existing barriers to entry and the overall market concentration. A market with high barriers to entry makes recoupment more plausible for a predatory firm. Conversely, in a market where entry is easy, even if a firm drives out rivals, new ones can quickly emerge when prices rise, making predatory pricing an irrational strategy.

Hypothetical Example

Imagine "MegaCorp," a large established beverage company, entering a small town where "LocalJuice," a smaller, family-owned business, has been the sole supplier of fresh orange juice. LocalJuice sells its juice for $5 per bottle, which covers its costs and allows a modest profit.

MegaCorp decides to launch its own orange juice brand in the town, immediately pricing it at $2 per bottle. This price is significantly below MegaCorp's own cost of production, leading to an immediate operating loss on each bottle sold. MegaCorp's objective is not to make a profit at this price, but to capture LocalJuice's customer base.

LocalJuice, unable to match the $2 price without going bankrupt, sees its sales plummet. Within six months, LocalJuice is forced to close its doors. Once LocalJuice is out of business and no new competitors emerge, MegaCorp gradually raises the price of its orange juice, first to $4, then to $6, and eventually to $7 per bottle. At $7, MegaCorp not only covers its production costs but also recoups the losses incurred during the predatory period, achieving profit maximization by leveraging its new monopoly position.

Practical Applications

Predatory pricing is a critical concept in antitrust law and competition policy, directly impacting how governments regulate markets to ensure fairness and prevent monopolies. Regulatory bodies, such as the Department of Justice (DOJ) and the Federal Trade Commission (FTC) in the United States, actively monitor markets for signs of such behavior to protect competitive landscapes.¹⁴, ¹⁵

In the airline industry, for instance, there have been accusations and lawsuits alleging predatory pricing. Airlines might lower fares on specific routes to uneconomic levels to force smaller carriers out of business or prevent new entrants. A notable example involved a lawsuit against American Airlines, which faced accusations of using predatory pricing strategies on certain routes to stifle competition from smaller airlines.¹³ Proving these claims requires extensive analysis of cost structures and market dynamics. Understanding predatory pricing is also crucial for businesses assessing the competitive landscape, especially when considering horizontal mergers or vertical integration, as these actions can sometimes raise antitrust concerns related to market dominance and potential anti-competitive behavior.

Limitations and Criticisms

Despite its theoretical appeal as a tool for eliminating competition, predatory pricing faces significant limitations and criticisms, making it difficult to prove and often economically irrational for the alleged predator.¹²

One major criticism is the high bar for proof in legal proceedings. Courts typically require evidence that the pricing was below a relevant measure of cost and that the firm had a reasonable prospect of "recoupment"—meaning it could recover its losses by subsequently raising prices in a less competitive market. T¹¹his recoupment element is particularly challenging, as it requires predicting future market conditions and the absence of new market entry once prices increase. M¹⁰any economists argue that predatory pricing is rarely a rational strategy because it is expensive and risky. The "predator" incurs substantial losses during the predatory phase, and there's no guarantee that competitors will exit, or that new ones won't emerge once prices eventually rise.

⁸, ⁹Moreover, an overly aggressive enforcement of predatory pricing rules could inadvertently stifle legitimate price competition. Companies may hesitate to lower prices aggressively, even when cost-justified, for fear of being accused of predatory behavior. This "chilling effect" could harm consumer welfare by preventing consumers from benefiting from lower prices. A⁶, ⁷cademic debate continues on whether current legal standards adequately balance the need to deter anti-competitive behavior with the desire to foster robust competition.

Predatory Pricing vs. Price Discrimination

While both predatory pricing and price discrimination involve charging different prices, their intent and legality are fundamentally different.

• Predatory pricing is a temporary strategy with the specific intent to eliminate or significantly reduce competition by selling products or services below cost. The ultimate goal is to achieve a monopoly and then raise prices to recoup initial losses. It is generally illegal under antitrust laws.
  *⁵ Price discrimination, on the other hand, involves charging different prices to different customers or groups of customers for the same product or service, but the intent is to maximize profits by capturing consumer surplus, not to destroy competitors. T⁴his practice is typically based on factors like willingness to pay, location, or purchase volume, and the prices are usually above the cost of production. Price discrimination is often legal, provided it does not violate anti-discrimination laws or constitute an abuse of market power that substantially lessens competition.

³The key distinction lies in the underlying objective and the impact on the competitive landscape. Predatory pricing seeks to eliminate rivals, while price discrimination aims to optimize revenue from existing market conditions.

FAQs

Is predatory pricing always illegal?

Predatory pricing is illegal under antitrust laws in many countries, including the United States. However, proving it in court is challenging, as it requires demonstrating intent to monopolize and the likelihood of recoupment, not just low prices.

How is predatory pricing different from normal competitive pricing?

Normal competitive pricing involves setting prices based on market demand, supply, and a company's cost structure, with the goal of profitability. Predatory pricing, by contrast, involves selling below cost with the specific intent to drive out competitors, accepting an economic loss in the short term for long-term market dominance.

²### Who benefits from predatory pricing?
In the short term, consumers may benefit from abnormally low prices. However, if successful, the long-term consequence of predatory pricing is typically reduced consumer welfare due to decreased competition, fewer choices, and eventually higher prices once the predator gains significant market power.

Why is it difficult to prove predatory pricing in court?

It is difficult to prove predatory pricing because plaintiffs must demonstrate two key elements: that the predator priced its goods or services below a relevant measure of cost, and that there was a reasonable prospect for the predator to later recoup its losses by raising prices in a less competitive market. Proving this intent and future recoupment is complex and often relies on extensive economic analysis.

¹### Can a small business be accused of predatory pricing?
While theoretically possible, accusations of predatory pricing are almost exclusively leveled against large firms with significant financial resources and existing market power. A small business typically lacks the capital to sustain prolonged losses necessary to drive out competitors and achieve a monopoly.