source : investopedia.com
Predatory Pricing Definition
What is Predatory Pricing?
Predatory pricing is the illegal act of setting prices low in an attempt to eliminate the competition. Predatory pricing violates antitrust law, as it makes markets more vulnerable to a monopoly.
However, allegations of this practice can be difficult to prosecute because defendants may argue successfully that lowering prices are part of normal competition, rather than a deliberate attempt to undermine the marketplace. And predatory pricing isn’t always successful in its goal, because of the difficulties in recouping lost revenue and successfully eliminating competitors.
Understanding Predatory Pricing
Effects of Predatory Pricing
A price war spurred by predatory pricing can be favorable for consumers in the short run. The heightened competition may create a buyers’ market in which the consumer enjoys not only lower prices but also increased leverage and wider choice.
However, should the price battle succeed in slaying all, or even some, of the market competitors, the advantages for consumers may quickly evaporate—or even reverse. A monopolistic marketplace might allow the company that holds the monopoly to raise prices as they wish, perhaps reducing consumer choice in the bargain.
In a predatory pricing scheme, prices are set low in an attempt to drive out competitors and create a monopoly.
Consumers may benefit from lower prices in the short term, but they suffer if the scheme succeeds in eliminating competition, causing a rise in prices and a decline in choice.
Prosecutions for predatory pricing have been complicated by the short-term consumer benefits and the difficulty of proving the intent to create a market monopoly.
Fortunately for consumers, creating a sustained market monopoly is no simple matter. For one, eliminating all rival businesses in a given market often comes with considerable challenges. For instance, in an area with numerous gas stations, it’s usually daunting for any one operator to cut prices low enough, for long enough, to drive out all competitors.
Even if such an effort worked, the strategy would succeed only if the revenue lost through predatory pricing could be recouped quickly—before many other competitors might enter the market, drawn by a return to normal price levels.
Dumping as Predatory Pricing
There’s even risk in a predatory-pricing practice known as dumping, in which the predator attempts to conquer a new foreign market by selling goods there, at least temporarily, for less than they charge at home. The challenge, especially in an increasingly global market, lies in preventing the “dumped” goods from being bought abroad and resold in the lucrative home market.
A famous cautionary tale from the early 20th century involves dumping into the U.S. by a German cartel that controlled the European market for bromine, an essential ingredient in many medicines as well as a vital element to photography. After American company Dow Chemical exported competitively priced bromine to Europe, the Germans retaliated, selling bromine in the U.S. at below their manufacturing cost.
Dow responded by simply buying the bromine stateside at the dumped price and reselling it profitably in Europe, which allowed the company to strengthen its European customer base at the expense of the German cartel.
Predatory Pricing and the Law
The same factors that make predatory pricing beneficial to consumers, at least in the short run—and often of dubious benefit to the predators, at least in the long run—have tended to hamper prosecution of supposed predators under U.S. antitrust laws.
The Federal Trade Commission says it examines claims of predatory pricing carefully. In turn, the Department of Justice, in a paper updated as recently as 2015, has asserted that economic theory based on strategic analysis supports that predatory pricing is a real problem, and that courts have adopted an overly cautious view of the practice.
The U.S. judiciary has indeed often been skeptical of claims of predatory pricing. Among the high bars set by the U.S. Supreme Court on antitrust claims is the requirement that plaintiffs show a likelihood that the pricing practices will affect not only rivals but also competition in the market as a whole, in order to establish that there is a substantial probability of success of the attempt to monopolize.
Further, the Court established that for prices to be predatory, they must be not simply aggressively low but actually below the seller’s cost. That said, it is not a violation of the law if a business sets prices below its own costs for reasons other than having a specific strategy to eliminate competitors.
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