What is Predatory Pricing?
A predatory pricing strategy, a term commonly used in marketing, refers to a pricing strategy in which goods or services are offered at a very low price point, with the intention of driving out competition and creating barriers to entry. In contrast to loss leader pricing, predatory pricing is aimed toward setting prices low for an extended period of time, long enough to, hopefully, drive the competition out of the market.
Understanding the Rationale Behind Predatory Pricing
Predatory pricing typically takes place during a price war. The ultimate goal behind this pricing strategy is to establish a strong market position and to drive out competitors. Predatory pricing may require a firm to sustain losses for a certain period of time and, thus, is typically only undertaken by large, established firms capable of absorbing short-term losses. The strategy is considered successful if the firm is able to recoup its short-term losses with much higher prices (and thus, higher profits) in the long term.
Effects of Predatory Pricing on an Industry
Predatory pricing in the short term benefits customers but harms all companies in the industry. In the short term, predatory pricing creates a buyer’s market, where customers are able to “shop around” and usually obtain goods at a lower price.
For companies, profitability declines as competitors actively try to undercut each other’s prices and divert traffic to their own business. The company that survives the price war and remains in the market is able to reap long-term rewards of increased market share, although it is not likely that it will be able to establish a monopoly in the industry.
After competitors are driven out, the remaining firm is able to raise prices and recover lost profits. As a customer’s willingness to pay declines as prices increase, the price appreciation works most effectively on inelastic goods. In the long term, customers suffer from higher prices and the now near-monopoly company is able to reap the profits of price appreciation.
The Legality of Predatory Pricing
Predatory pricing is deemed illegal and anti-competitive in many countries. For example, in Canada, those that engage in predatory pricing face a monetary penalty. Allegations of wrongdoing are often hard to prove, as firms can claim they were merely trying to be competitive with their pricing, rather than deliberately acting to drive out their competition.
Allegations of Predatory Pricing: Air Canada
In 2001, Air Canada faced allegations of predatory pricing against two smaller competitors (WestJet and CanJet) by Canada’s Commissioner of Competition. Air Canada introduced special fares to match competitor’s prices of $89 to $99 for one-way travel from Halifax to St. John’s, Montreal, or Ottawa. In the past, the airline had priced such flights at more than $600.
Other airlines filed complaints regarding Air Canada’s anti-competitive behavior, and a representative of the company’s corporate development and strategy department came out and stated: “We are not aware of any precedent anywhere where an airline has been prevented from matching pricing.” Previously, Air Canada faced a cease-and-desist order from the Competition Bureau and was forced to withdraw a set of low fares.
As previously noted, proving predatory pricing can be very difficult, as companies can deem it as price competition. In this specific case, Air Canada explained that they were matching prices and were not engaged in predatory pricing.
Example of Predatory Pricing
Fresh Foods Ltd. is a local mom and pop grocery store that’s been serving its community for many years. Recently, an internationally renowned grocery store company decided to locate one of its stores in the same community. Fresh Foods then faced significant pricing pressure from the new store as the competitor started lowering prices over the past couple of weeks. To remain competitive, Fresh Foods began reducing its prices to match its competitor.
After months of pricing pressure, the local mom and pop grocery store decided to close up, as it could no longer sustain such low prices. With Fresh Foods eliminated, the now monopoly grocery store company decided to raise its prices significantly. With nowhere else to shop for groceries, customers were forced to accept the new, hgher prices.
This example provides a good illustration of how predatory pricing can have a long-term negative impact on consumers.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful: