In general, predatory pricing refers to anti-competitive activities taken by a company that is dominant in the market to protect its market share from new or existing competitors. Predatory pricing involves temporarily pricing a product low enough to end a competitive threat.
Predatory pricing is often prohibited under national competition laws.
How predatory pricing works
Predatory pricing is the practice of a dominant firm (for example monopoly) that sells its product at a loss in order to drive some or all competitors out of the market.
If the dominant firm lowers its price enough, until it is below the average cost of its competitors, the other firms will respond by lowering their prices in order to compete with the predatory pricer.
If the competitors fail to cut their prices enough, they will lose their market share because people will buy cheaper goods from the predatory pricer.
The competitors will lower their prices below their average cost. This will cause them to lose money on every item they sell. If the situation is happening for period that is long enough, the other competing firms will eventually go bankrupt and fall out of the market.
If this happens and the competition has been forced out of the market, the predatory pricer then has fewer competitors or even a monopoly.
The predatory firm raises its price, compensating itself for the money it lost while it was engaged in predatory pricing, and earns monopoly profits forever after.
Why predatory pricing is bad?
Predatory pricing forces competition out of the market which is bad not only for prices but also for development and quality.
Prices...Although consumers might enjoy a temporary period of low prices during price wars, the predatory pricer will eventually raise prices above what the market would otherwise pay.
Assumptions for predatory pricing
Generally, the following elements must exist to constitute predatory pricing:
Market power: The predator must have market power to unilaterally increase its prices.
Low prices: The predator must charge prices that fall below a predatory price standard. Prices must be below average total costs, and near or below average variable costs.
Strategic policy: There must be evidence of a clear policy of selling at predatory prices, not just occasional or reactive price cutting.
Potential: There must be a reasonable expectation that the predator will be able to recoup its losses after its predation ends.
Predatory pricing in reality
In September 2000, Wal-Mart was hit with three separate charges of predatory pricing. Government officials in Wisconsin and Germany accused the retailer of pricing goods below cost with intent to drive competitors out of the market. In Oklahoma, Wal-Mart faces a private lawsuit alleging similar illegal pricing practices.
Back in 1996, for example, Microsoft started giving away Internet Explorer, its Web browser, and in some cases arguably even encouraged people to use it by offering free software and marketing assistance. The strategy was crucial to the company's success in snatching market dominance away from archrival Netscape.
Alex Eckelberry of security software vendor Sunbelt Software and other commentators suggest that Microsoft currently practices predatory pricing in the security software field.