The term Predatory refers to the practice of being inclined or intended to exploit others for personal gain. Predatory pricing is a pricing strategy in which goods or services are offered at such a lower price which makes it difficult for the competitors to survive. The main purpose behind predatory pricing is to drive out competition, creating a monopoly and barriers to the new entry. Once the competition has been eliminated, it is assumed that the firm will set its prices to a higher level and thus it will recover the losses.
Get complete CFA Online Course by experts Click Here
How Predatory Pricing works?
Predatory pricing is a pricing strategy in which products are offered at the lowest possible price by a firm. This strategy works best for the firm that has the capability to afford the short-term loss. Predatory pricing strategy may be employed with different objectives such as gaining maximum market share, long-term profitability, making barriers to entry, removing existing competitors, etc.
In the initial stage of the Predatory Pricing strategy, the firm tends to offer the product at the lowest price for a short period of time and thus, create a difficult situation for competitors. The firm which is employing this strategy sees low cost as a good way to increase the market share and kicks out the competitors. Customers will benefit from the lower price for the short term. Competitors, in such a situation, may not be able to survive. Due to this, the predatory firm will have a monopoly in a particular industry. Once the monopoly is created, the predatory firm will raise the price sharply in order to set-off earlier losses. Thus, in the long term, the firm will enjoy the benefit of ruling the market and customers would be forced to pay higher prices due to monopoly.
How Predatory Pricing affects the Market?
- Creates buyer’s Market: Initially, the Customer will benefit from excessively lower prices i.e. predatory price of the goods or services. They might also benefit from aggressive competition in the market, as competitors will try to hold their ground with higher-quality products and services. Thus, Predatory pricing in the short- term benefits customers and creates a buyer’s market.
- Reduced Profitability for business/company: Predatory pricing, in the short term, will benefit the customers but harms all the companies in an industry. The company employing predatory pricing may run, initially, at loss or profitability of such company man reduced at higher extent due to price cut.
- Effects on Competitors: If a company is employing a predatory pricing strategy, there is a high chance of price war. Competitors of such a company will also finance a loss in order to keep pace with the predatory company. Competitors actively try to undercut each other’s prices and drive the traffic to their own business. In such practice, the companies which are not able to shoulder the loss will be in the worst condition as they will lose the market share.
Get complete FRM Online Course by experts Click Here
- Competitors will starve out: Competitors who are not capable of surviving against predatory pricing will eventually be starved out of the market. In such a situation, the predatory firm is likely to create a monopoly in the industry.
- Prices are likely to rise: In the long term, prices are likely to increase sharply to compensate for the initial loss business had. Customers are likely to suffer from abnormally higher prices due to monopolies created. This works most in the case of inelastic goods.
- Quality drop and lack of innovation may take place: Under such a situation, the quality of goods or services is likely to drop as there will be no competition around. The innovation can be stifled as the monopoly company will be controlling the market.
Example of Predatory Pricing:
In the telecommunication industry in India, the firm Reliance Jio has offered unlimited calling and internet data for free for a shorter period of time. This made it difficult for competitors like Bharti Airtel, Vodafone Idea, etc. This strategy helped Reliance Jio to gain a large market share in India.
Author: Hetvi Shah
About the Author: Hetvi is a BBA(Finance) graduate. She is currently pursuing an MBA with Finance specialization. She has a keen interest in Financial Market, Financial Management, and Financial Analysis.