Strategic planning is one of the core ingredients of a successful business. The primary objectives of any business include profits as well as market penetration and market growth. Apart from a good marketing strategy and quality products/services, a competitive pricing strategy is equally important.
Introducing low-priced products or reducing current prices to have a better market reach is a fine move. However, if it keeps hitting lower prices, competitive pricing can turn into predatory pricing because there is a marginal difference between them. This pricing strategy is not a healthy practice by any means, and this piece of writing accounts for everything you need to know about this strategy.
What is Predatory Pricing?
Predatory pricing occurs when a seller/company/firm sets significantly low prices for its products or services to minimize the competition. The basic objective of this strategy is to create a monopoly in the target market.
Along with societal or environmental obligations, the core purpose of running a business is to earn profits. But predatory pricing is the opposite concept and it may also include setting the prices even below the break-even point. I.e., sustaining losses. Then why would someone go with a predatory pricing strategy when there are strong chances of suffering financial losses?
How Predatory Pricing works
Before jumping to the detailed explanation of how this pricing strategy works, it is important to know that every firm cannot adopt this strategy. Or, you can say that not every seller has the resources to adopt this pricing strategy. Here is how this thing works:
Stage 1 – Predation
As mentioned above, not every firm can adopt this pricing strategy. Predatory pricing is feasible only for large scale organizations. The process starts with a dominant firm sets its prices below competitive prices. These firms have large scale production units, and their overall costs are already lower than many small-scale production units.
The price reduction will definitely reduce immediate profits, but it will force the competitors to reduce the prices. At this stage, small-scale entities or new entrants may already be thinking about closing their setups. If the competitors also reduce their prices and still operating, the dominant firm will further lower the prices, and this time the firm may start operating at a below-cost rate.
Operating at a below-cost rate will cause immediate losses, but the competitors will have to lower their prices again. This time, there will be no room for many competitors with no other option than closing their operations. These big size firms have massive capitals they can easily negotiate these short-term losses.
Stage 2 – Recoupment
Once the competition reduces and the firm gets desired results, it readjusts its prices according to the remaining competitors in the market. If the competition is negligible, then the price increment is higher and vice versa.
At the recoupment stage, consumers are highly vulnerable to exploitation. Consumers are left with no other choice except buying from the only supplier with minimal competition. This is how these giant companies wipeout competition and create a monopolistic market.
Predatory Pricing v/s Competitive Pricing
Technically, it becomes difficult to differentiate between predatory pricing and competitive pricing because you cannot accuse an organization if it reduces the prices. Organizations have complete authority to increase or decrease their prices whenever they want. If a company charges less for similar services, it cannot be considered predatory pricing.
However, this difference between competitive and predatory pricing becomes prominent during the recouping phase. During the recouping phase, the firm readjusts its prices to recover the losses incurred during stage one. The readjusted prices are comparatively way higher as compared to the previous prices. This practice causes great harm to end consumers because they are left with no other choice.
Penetration Pricing v/s Predatory Pricing
Predatory pricing, as mentioned above, can be very difficult to identify. That is because there are other pricing strategies similar to predatory pricing. For instance, penetration pricing is another pricing strategy used by companies, but it is completely legal.
Most of the time two types of businesses implement this pricing strategy i.e. new businesses or those businesses launching new products and services. It is always difficult to make a mark in the market with a new product at a competitive price. Therefore, companies start with lower prices, even lower than the break-even point, to initiate word of mouth. Once the product penetrates the market, the company increases its prices.
Is Predatory Pricing illegal?
Any business practice that endangers the fair market competition is illegal. The legislation in the United States has always been very strict against unfair or monopolistic behaviors. Predatory pricing also falls in the category of monopolistic behavior, so it is an illegal practice not only in the United States but all over the world.
Moreover, predatory pricing has further sub-categories, and according to American Antitrust laws, most of its sub-categories are strictly prohibited. Antitrust laws ensure the preservation of a fair and competitive market and minimize monopolistic practices.
Effect of Predatory Pricing
Predatory pricing affects the market in the short term as well as long term. Here is how:
In the short run, predatory pricing is like a “dream come true” for consumers. The predatory company (employing predatory pricing) will lower the prices and most likely to suffer short-term losses. Other companies will also lower their prices to stay in the competition.
Those who will not be able to reduce their price will face decline in the sales and lead to losses. Due to price differences their customers will switch to low-priced products. This outrageous decrease in prices will be very beneficial for consumers in the short run. If the competitors can hold it for long, the price war may prolong.
Sooner or later, the competition will start getting weaker and weaker because every seller cannot sustain losses for longer periods. As soon as the competition minimizes, the predatory company will increase the prices gradually to cover up the losses sustained earlier. Ultimately, consumers will have to pay the price.
Advantages of Predatory Pricing
Elimination of Competitors
This strategy has one single purpose, and that is to hurt competitors. A company that employs predatory prices and can hold long enough will minimize the competition in the market.
Barriers for New Entrants
It is highly unlikely that new entrants step into the market with huge capital and the ability to absorb initial losses. With predatory prices already prevailing in the market, new entrants will find it almost impossible to enter the market.
Once the predatory company succeeds in eliminating the market competition, it can easily create a monopolistic environment charging high prices for its products and services. Also, the company may lower the product quality if there is no one else left to compete.
Disadvantages of Predatory Pricing
It is not a Long-term Policy
Predatory pricing is not an easy thing to implement, and that too in the long run. A company cannot absorb losses for longer periods because it can also affect its stock prices, and it is uncertain how long the competitors can compete. If the competitors are strong enough to hold their positions, this strategy will fail.
Predatory Pricing is illegal
Predatory pricing is illegal to practice because it promotes monopolistic market behavior. If something is illegal, the chances of success become bleak.
Examples of Predatory Pricing
Amazon.com can be one of the best examples of creating a monopoly through predatory pricing. Along with many other products, Amazon is the largest provider of printed and electronic books.
Amazon sells books at lower prices as compared to their competitors. As a matter of fact, Amazon has already conquered 90% of the global market because only Amazon can sell a $16 book for $11. Moreover, there are a handful of “weak” competitors left to compete with this juggernaut. The publishing industry is facing grave danger in terms of fair competition. Amazon may start exploiting writers if the list of publishers keeps shrinking like this.
It is evident that this pricing strategy is not good for the market as well as consumers in the long run. Yes, the initial days are enticing for consumers, but the after-effects are horrible. However, employing predatory pricing is not that easy, and only large-scale organizations can think about implementing this strategy. Otherwise, this is not a pragmatic approach for local businesses.