Predatory Pricing: Objectives and Policies of Firms

Predatory pricing is a business strategy where a firm lowers its prices to a level that is below the average variable cost (AVC) of its competitors. The aim is to drive competitors out of the market, allowing the predatory firm to then raise prices and recoup its losses, ultimately gaining a dominant market position.

Objectives of Firms Engaging in Predatory Pricing

Firms employ predatory pricing with several key objectives:

• Eliminating Competition: The primary goal is to remove rivals from the market. By selling at unsustainable prices, the predator aims to force competitors to exit, either by incurring losses or being unable to compete effectively.
• Gaining Market Share: Even if competitors don't exit, predatory pricing can lead to a significant increase in the predator's market share. This allows the firm to capture a larger portion of consumer demand.
• Building Barriers to Entry: A dominant market position created through predatory pricing can deter new firms from entering the market. Potential entrants may perceive the existing firm's ability to aggressively lower prices as a significant obstacle.
• Recouping Losses: The initial losses incurred during the predatory pricing phase are intended to be recovered later when the predator raises prices after eliminating competition.

Policies and Tactics Used in Predatory Pricing

Firms utilize various policies and tactics to implement predatory pricing strategies:

1. Temporary Price Cuts: The most common tactic involves temporarily lowering prices significantly below cost. This is often done for a specific period to inflict financial damage on competitors.
2. Capacity Utilization: Predatory pricing is more effective when the predator has substantial spare capacity. This allows them to sustain losses for a longer period.
3. Subsidized Sales: The predator may offer products or services at a loss to attract customers and discourage competitors from competing on price.
4. Bundling: Combining products or services at a low price can create a more attractive offer than competitors can match, even if the individual components are sold at a profit.

Legal Considerations and Challenges

Predatory pricing is often illegal under antitrust laws, particularly in countries like the United States and the European Union. Legal challenges focus on demonstrating the intent to eliminate competition and the likelihood of recouping losses.

Proving predatory pricing can be difficult. Authorities need to establish:

1. Below-Cost Pricing: Demonstrate that the firm's prices are below its average variable cost (AVC).
2. Intent to Monopolize: Prove that the firm intended to eliminate competition and gain a monopoly.
3. Reasonable Prospect of Recoupment: Show that the firm had a reasonable chance of raising prices to recoup its losses.

Table: Comparison of Predatory Pricing with Other Competitive Strategies

In conclusion, predatory pricing is a risky but potentially rewarding strategy. While it can lead to significant gains for the predatory firm, it also carries substantial legal risks and requires careful planning and execution.