What it means
Cutting prices is ordinary competition, so what separates predatory pricing from a good deal is the plan sitting behind it. The seller knowingly accepts losses now, for a period, in order to remove a rival and then recover those losses through higher prices afterwards.
Competition authorities generally look for two ingredients. The first is a price set below a sensible measure of cost; the second is a realistic prospect of recoupment, meaning the seller can later raise prices enough to make the exercise pay.
The cost benchmark does most of the work in any investigation. Authorities often compare the price with average variable cost, which is the cost that rises with each extra unit sold, because selling below that level has almost no innocent commercial explanation.
For most managers the practical risk is the accusation rather than the strategy itself. Aggressive launch discounts, loss leaders and free bundled add-ons can all look predatory in hindsight, particularly if internal messages talk about starving a named competitor out of the market.
Proven cases are rarer than the phrase suggests, because recoupment is genuinely hard. If prices rise again, new entrants can appear quickly, which is why authorities concentrate on markets with high barriers to entry such as heavy infrastructure, licences or strong network effects.
In practice
Real-world examples
Example 1
A national supermarket chain sells own-brand milk at 40 cents below what it pays the dairy in every town where a discount grocer has just opened, and at full price everywhere else. The geographic pattern, rather than the discount itself, is what draws a regulator's attention.
Example 2
A software firm offers its scheduling product free to any customer switching from a smaller rival, absorbing hosting and support costs of roughly $30 per account per month. When the rival files a complaint, the firm has to show the giveaway was a genuine customer acquisition programme with a planned end date.
Example 3
An airline adds three daily flights on a route where a start-up carrier has just launched and prices seats below fuel and landing costs for the season. Once the start-up withdraws, fares on the route rise above their previous level, which is exactly the pattern investigators look for.
Think of it
Imagine a heavyweight boxer who enters a small village gym and pays people to let him knock out every local trainer, so eventually he is the only one left and can charge whatever he likes for lessons.
Formula
Calculation
There is no single legal formula, but the commercial test can be written down clearly:
Loss per unit = Selling price - Average variable cost
Total predation loss = Loss per unit x Units sold
Recoupment period = Total predation loss / Extra annual profit once the rival exits
A regional courier normally sells a delivery for $10 against an average variable cost of $8, giving a margin of $2 per delivery on 200,000 deliveries a year, or $400,000 of contribution. To squeeze out a new entrant it drops the price to $5 for a year. Loss per unit becomes $5 - $8 = -$3, so the total predation loss is $3 x 200,000 = $600,000.
The entrant closes, and the courier raises the price to $12. Margin per delivery is now $12 - $8 = $4, giving $4 x 200,000 = $800,000 of contribution, which is $400,000 more than the $400,000 it earned at normal prices. Recoupment period = $600,000 / $400,000 = 1.5 years, so the strategy only pays if the courier can hold that higher price for at least eighteen months without a new competitor arriving.Case study
Seen in the real world
In this illustrative and entirely fictional example, Harborline Ferries operated the only passenger service to a small island until Bay Runner Boats launched a competing crossing. Harborline cut its single fare from $18 to $6, well below its variable cost of $11 per passenger, and ran the lower fare for two summers.
Bay Runner Boats ran out of cash and stopped sailing. Harborline then set the fare at $24, and a local business association complained to the competition regulator, pointing to board minutes that described the discount as a plan to make the route unattractive to newcomers.
The illustrative outcome was expensive. Harborline was ordered to hold fares at a supervised level for three years and to keep records of route profitability, which removed most of the benefit it had hoped to gain from the exercise.
Watch out
Common mistakes
- Assuming any very low price is predatory. Discounting above variable cost is normal competitive behaviour and is rarely challenged.
- Believing intent alone is enough to prove a case. Without a credible route to recouping the losses, most authorities will not act.
- Treating a loss leader as the same thing. A loss leader is priced low to sell profitable items alongside it, not to eliminate a rival.
Questions
People also ask
Is predatory pricing always illegal?
It is unlawful in most developed markets when practised by a firm with market power, but a small business with no ability to dominate a market is unlikely to be pursued.
How do we defend an aggressive launch price?
Document the commercial reasoning, set a clear end date, and show the price sits above your average variable cost.
Who typically brings a complaint?
Usually the affected competitor, though customers, trade bodies and regulators reviewing a market can all start an investigation.