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Predatory Pricing

Goods or services are priced at a very low price point to drive out the competition

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 priced 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 towards setting prices low for an extended period of time to drive out the competition.

 

Predatory Pricing

 

Understanding the Rationale Behind Predatory Pricing

Predatory pricing typically takes place during a price war, and the outreaching goal behind the pricing strategy is to establish a strong market position and to drive out competitors. Predatory pricing requires the firm to sustain losses for a certain period of time and thus, is typically only undertaken by large, established firms. The strategy is considered successful if the firm is able to recoup its short-term losses with much higher prices (and thus, profits) in the long term.

 

Effects of Predatory Pricing on an Industry

 

Short-Term Effects

Predatory pricing in the short term benefits customers due to lower prices but harms all companies in the industry. In the short term, predatory pricing creates a buyer’s market where customers are able to purchase goods at a lower price and “shop around.”

For companies, profitability declines as competitors actively try to undercut prices and divert traffic to their business. The company that survives the price war and remains in the market is able to reap the long-term rewards and establish a monopoly in the industry.

 

Long-Term Effects

After competitors are driven out, the remaining firm is able to raise prices and recover lost profits in the short term. 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 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 are engaged in predatory pricing face a monetary penalty. Allegations of wrongdoings are hard to prove as firms can deem it as price competition rather than a deliberate act to drive out the 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. Usually, the airline prices the trips 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 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 indicated by this article, proving predatory pricing is very hard 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 pops 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 price and match its competitor.

After months of pricing pressure, the local mom and pops grocery store decided to close up as it could no longer sustain such low prices. With French Foods eliminated, the now monopoly grocery store company decides to raise its price significantly. With nowhere else to shop for groceries, customers are forced to abide by the new prices.

 

Related Readings

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 resources will be helpful:

  • Click and Mortar
  • Competitive Advantage
  • Market Economy
  • Oligopoly

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