Introduction
Predatory pricing is a controversial strategy where a dominant firm slashes prices below cost to drive competitors out of the market. Once rivals exit, the predator raises prices to recoup losses, often leading to monopolistic control. I’ve seen this play out in various industries, from retail to tech, and the consequences can reshape entire markets. In this guide, I’ll break down predatory pricing, how it works, its legal implications, and real-world examples..
Table of Contents
What Is Predatory Pricing?
Predatory pricing occurs when a company intentionally sets prices so low that competitors can’t sustain their operations. The goal is simple: eliminate competition and gain market dominance. While low prices may seem beneficial to consumers in the short term, the long-term effects can be harmful.
The Economics Behind Predatory Pricing
To understand predatory pricing, we need to examine the cost structures involved. A firm engages in predatory pricing if it sells below its average variable cost (AVC). The logic is that no rational business would sell below cost unless it aims to push competitors out.
The basic condition for predatory pricing can be expressed as:
P < AVCWhere:
- P = Price per unit
- AVC = Average variable cost per unit
If a company sustains P < AVC long enough, weaker competitors will bleed cash and exit.
How Predatory Pricing Works
Predatory pricing follows a predictable cycle:
- Price Slashing – The dominant firm drops prices below cost.
- Competitor Erosion – Rivals lose money and either exit or reduce operations.
- Market Dominance – The predator gains control over supply.
- Price Inflation – Once competition is gone, prices rise above competitive levels.
Example Calculation
Let’s say Company A wants to drive Company B out of the market.
| Cost Metric | Company A | Company B |
|---|---|---|
| Average Variable Cost (AVC) | $5 | $6 |
| Current Market Price | $7 | $7 |
Company A decides to slash prices to $4, below its AVC.
P_{A} = 4 < AVC_{A} = 5Company B can’t match this price because:
P_{B} = 4 < AVC_{B} = 6After months of losses, Company B shuts down. Company A then raises prices to $8, enjoying monopoly profits.
Legal Perspective: Is Predatory Pricing Illegal?
In the U.S., predatory pricing cases fall under Section 2 of the Sherman Antitrust Act and the Robinson-Patman Act. However, proving predatory pricing is difficult. Courts often use the “Areeda-Turner Test”, which states that pricing below AVC is presumptively predatory, while pricing above AVC but below average total cost (ATC) requires further analysis.
\text{Predatory if: } P < AVC \text{Debatable if: } AVC \leq P < ATCLandmark Cases
- Brooke Group Ltd. v. Brown & Williamson Tobacco Corp. (1993) – The Supreme Court ruled that predatory pricing must show a dangerous probability of recouping losses.
- Walmart’s Early Expansion – Critics accused Walmart of pricing below cost to crush local retailers, though courts rarely sided against them.
Real-World Examples
1. Amazon vs. Diapers.com
Amazon reportedly sold diapers at a loss to undercut Diapers.com. After Diapers.com struggled, Amazon acquired it. This case highlights how deep-pocketed firms use predatory tactics.
2. Uber’s Subsidized Rides
Uber burned billions subsidizing rides to dominate markets. Once competitors like Lyft weakened, Uber reduced driver incentives and raised fares.
Defenses Against Predatory Pricing
Small businesses can adopt strategies to survive predatory attacks:
- Differentiation – Offer unique value beyond price.
- Cost Efficiency – Reduce operational costs to withstand price wars.
- Legal Action – File antitrust complaints if predatory intent is clear.
Conclusion
Predatory pricing is a high-risk, high-reward strategy that can distort markets. While consumers may enjoy temporary low prices, the long-term effects—reduced competition, higher prices, and stifled innovation—are concerning. Regulators must balance between preventing abuse and allowing healthy competition.
