Definition of Predatory Pricing
Predatory pricing occurs when a firm sells a good or service at a price below cost (or very cheaply) with the intention of forcing rival firms out of business.
- Predatory pricing could be a method to deal with new firms who enter an industry.
- If a monopoly is enjoying supernormal profits, it is likely to attract new firms into the industry – who would reduce the incumbent’s profitability.
- However, in response, the incumbent monopoly could cut prices and make a temporary loss.
- These low prices and operating at a loss may force the new firm out of business.
- The incumbent monopoly may have significant savings to finance a price war, whilst the new firm is more vulnerable due to financing cost of entering the market.
- If successful, the monopoly firm regains its monopoly power, but also its action of predatory pricing discourages other firms from trying to enter.
Predatory Pricing and the Public Interest
If predatory pricing leads to an increase in monopoly power, then it will harm the public interest because it leads to higher prices in the long term. However, predatory pricing could be confused with a very competitive market. Consumers can benefit if prices fall and all the firms stay in business.
Predatory Pricing and Regulation
Predatory pricing in the UK is illegal. It is prohibited under EU Competition Law to sell goods at a loss with the purpose of forcing other firms out of business.
Example of Predatory Pricing
Darlington Bus wars (1994)
In the Darlington bus wars, Busways (owned by Stagecoach from July 1994) a new entrant into the deregulated bus markets, offered free bus travel to try and force the rival Darlington Bus company out of business. Busways were also successful in attracting bus drivers from its rival (by paying higher wages. For a time, they also offered free bus rides – attracting customers from their rivals The result was that Darlington Transport Company (DTC) went out of business leading to monopoly power for the remaining Busways company.
In a report into the entry of Busways, the Monopolies and Mergers commission reported that the actions of Busways did amount to predatory pricing. (Report by MMC)
“It was the combination of Busways’ actions in recruiting so many of DTC’s drivers so quickly, registering services on all its routes and running free services which caused DTC’s final collapse. We find these actions to be predatory, deplorable and against the public interest.”
Since bus deregulation, bus use in Darlington has fallen from 10 million journeys a year (2001) to 6.6 million (2014).
Aberdeen Newspaper was fined by the OFT for predatory pricing and trying to eliminate its main competitor. Aberdeen Journals were fined £1.3million.
‘Aberdeen Journals deliberately incurred losses in a persistent campaign to remove its only direct rival from the market. This campaign continued despite the fact that the Competition Act 1998 prohibited predatory pricing from March 2000, and despite an OFT investigation already being in train. This was a serious infringement of the law, and the penalty should act as a deterrent to others.’ [OFT link]
Microsoft web browser – internet explorer
Microsoft’s decision to offer its web browser (Internet Explorer) helped to make it very difficult for its main competitor (Netscape) who was also forced to offer its web browser for free.
Partial Predatory Pricing
Often firms engage in partial predatory pricing. This could be termed ‘loss leaders’ For example, supermarkets sell some items like bread and baked beans at a discount to attract customers. But, overall they remain profitable.