What Is Predatory Pricing?
Predatory pricing is the illegal business practice of setting prices for a product unrealistically low in order to eliminate the competition.
Predatory pricing violates antitrust laws, as its goal is to create a monopoly. However, the practice can be difficult to prosecute. Defendants may argue that lowering prices is a normal business practice in a competitive market rather than a deliberate attempt to undermine the marketplace.
Predatory pricing doesn’t always work, since the predator is losing revenue as well as the competition. The predator must raise prices eventually. At that point, new competitors will emerge.
- In a predatory pricing scheme, prices are set unrealistically low in order to eliminate competitors and create a monopoly.
- Consumers benefit from lower prices in the short term but suffer in the long term as the successful predator has eliminated choice and is free to raise prices.
- Predatory pricing has been difficult to prove in court.
Understanding Predatory Pricing
To understand how predatory pricing affects markets, and eventually consumers, it is necessary to take a longer view.
Consumers enjoy the short-term benefits of competitive pricing. Heightened competition creates a buyer’s market in which the consumer enjoys lower prices, increased leverage, and wider choice.
However, if one company cuts its prices unrealistically low or even below cost, others competitors will be forced to abandon the market. At that point, the advantages for consumers quickly evaporate—or even reverse.
A monopolistic marketplace allows a single producer to raise prices, safe in the knowledge that the consumer has no alternatives.
The Effects of Predatory Pricing
Luckily for consumers, predatory pricing practices tend to backfire in the long run. In order to drive all rivals out of a business, the predator must cut prices below their manufacturing costs. The intent, of course, is to raise prices back to normal or above normal once the competition is gone.
The problem with that strategy is that rival companies will see the opportunity to enter or re-enter the business once prices stabilize.
The Pitfalls of Predatory Pricing
Fortunately for consumers, predatory pricing isn't an easy strategy to pull off. Eliminating all rivals in a given market comes with considerable risk.
For instance, if a town has many gas stations, any one of them could attract more business by cutting prices deeply. Sustaining those prices long enough to kill off the competition is harder.
Even if such an effort worked, the strategy will succeed only if the revenue lost through predatory pricing can be recouped quickly. But as soon as the sole gas station raises its prices to normal levels, other competitors will spot an opportunity and step in.
Dumping as Predatory Pricing
Dumping is a form of predatory pricing practiced by businesses attempting to dominate a foreign market. Typically, businesses that practice dumping sell their products in a foreign market for cheaper than they can at home.
An increasingly global marketplace has added a new risk to those attempting to dump products: Some dumped goods are bought abroad and then shipped back to the home country to be sold at higher prices.
A famous cautionary tale from the early 20th century involved dumping by a German cartel that controlled the European market for bromine, then an essential ingredient in many medicines and a vital element in photography. After the American company Dow Chemical started exporting competitively priced bromine to Europe, the Germans retaliated by exporting bromine to the U.S. for sale 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
Prosecution of predatory pricing is difficult, given that the prosecutors are trying to prove that low prices can be a bad thing and even an illegal one.
The Federal Trade Commission (FTC) says it examines allegations of predatory pricing “carefully” but that the courts have been “skeptical” of such claims. The U.S. Department of Justice (DOJ) has asserted that predatory pricing is a real problem and that courts have adopted an overly cautious view of the practice.
A high bar has been set on antitrust claims in general. The U.S. Supreme Court has required 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 that the attempt to monopolize will succeed.
Further, the court established that predatory pricing must be not just aggressively low but actually below the seller’s cost.
That said, it is not illegal for a business to set prices below its costs for reasons other than having a specific strategy to eliminate competitors.
Example of Predatory Pricing
One of the most active areas of enforcement against predatory pricing is the U.S. government's effort to crack down on exporters who sell their products too cheaply in the U.S. The International Trade Commission of the Commerce Department defines too cheaply as "less than fair market value."
Any U.S. company can file a petition against any foreign company that it believes is selling its goods at less than fair market value.
Current complaints under review include a wide range of products from many countries, from frozen shrimp and steel nails shipped from India to lemon juice from South Korea.
If the International Trade Commission finds that an importer has sold its products for less than fair market value, it has the power to impose a duty at a rate that is calculated to eliminate any benefit derived from dumping goods.
What Does Predatory Pricing Mean?
Predatory pricing is the lowering of prices by one company for the purpose of driving rivals out of the business. At that point, the company can raise prices, and in fact, must raise prices in order to recoup losses and survive. The practice is illegal because, if successful, it creates a monopoly and eliminates choice.
Which Companies Have Been Accused of Predatory Pricing?
Walmart is among the companies that have been accused of predatory pricing. In 1993, a judge ordered the retailer to stop selling drugs and health and beauty products below cost after three stores in Conway, Arkansas, accused the company of undercutting them to drive them out of business.
This wasn’t an isolated case. Similar allegations were leveled at Walmart from rival companies in other states, and the company has been accused of predatory pricing on several other occasions.
Is Predatory Pricing Illegal?
Predatory pricing is illegal but it's difficult to prove. Predatory pricing violates antitrust laws in the U.S. and other countries that are intended to ensure fair competition. The prosecutors have to prove that the accused company did not just intend to compete but intended to eliminate the competition.
The Bottom Line
Is that product an example of predatory pricing or just a great bargain? From the consumer's viewpoint, it's hard to tell.
If it's predatory pricing, the low prices will last only enough for the manufacturer to drive its rivals out of business. At that point, it must raise prices in order to make up for the losses it incurred earlier by cutting its prices too low. And it can raise prices with impunity, now that the competition has been eliminated.