Predatory pricing is a pricing strategy used by an established firm to eliminate competition from equally efficient firms, and secure a monopoly position in a previously competitive market. A firm practicing predatory pricing lowers its price below cost and maintains it there until equally efficient competitors are forced to incur unsustainable losses and exit the market. The firm then raises its price to a monopoly level in order to recoup its lost profits.
The US Supreme Court defines predatory prices as “below-cost prices that drive rivals out of the market and allow the monopolist to raise its prices later and recoup its losses”.
Predatory pricing is a risky strategy. The firm involved incurs high up-front losses, with no guarantee of future gains from monopolization. The strategy will only be profitable if, once all competitors have been forced out of the market, the incumbent is able to raise its prices to a monopoly level and keep them there. If the firm is subject to either direct price regulation or some other form of control, predatory pricing is unlikely to succeed.
Predatory pricing requires high barriers to entry. If firms are able to enter the market easily, then each time the incumbent increases its price this will attract new entrants into the market, forcing the incumbent to drop its price again.
Predatory pricing is notoriously difficult to prove. It can be difficult in practice to distinguish predatory pricing from aggressively competitive below-cost pricing (such as “loss leaders” and promotional activities).
Box 2.5: UK: UUNet's claims of predatory pricing against BT
In 1995, a competing internet service provider, UUNet, alleged that BT was engaging in predatory pricing for its internet access service (provided through BTNet). UUNet complained that a BTNet offer at a price 9 times less then BT’s comparable services was anti-competitive, and BTNet was not recovering its cost; furthermore, BT was offering a free trial period of subscription. The British regulatory agency Oftel (now Ofcom) found in 1997 under the following conditions:
- Barriers to entry were low and, therefore, BT could not expect to exclude competitors from the market and gain the market power needed to recoup losses in the long run
- BT’s other internet services were distinguishable from the BTNet service and, therefore, UUNet’s comparison was not well-founded
- Early BTNet losses not recovered were consistent with start-up business trends and that BT’s projected figures showed more profitability
- Free promotional subscriptions were commonplace in the industry, and BTNet had limited the offer to the initial period
Oftel’s final ruling was that BT had not engaged in any form of predatory pricing, although Oftel did continue to monitor BT due to its significant market presence.
Source: Ofcom's Competition Bulletin Issue 6, October 1997
Establishing whether predatory pricing has taken place requires that two tests be met (see Figure 2.7):
Figure 2.7: Remedies for Predatory Pricing
Is the Firm Pricing Below Cost?
There is no universally accepted test to determine whether a firm is pricing below cost. According to EC case law two tests are possible to find an abuse in the form of predatory pricing:
· where variable costs are not covered, an abuse is automatically presumed;
· where variable costs are covered, but total costs are not, the pricing is deemed to constitute an abuse if it forms part of a plan to eliminate competitors.
Box 2.6: France: Wanadoo DSL pricing
From the end of 1999 to October 2002, Wanadoo, a 72% owned subsidiary of France Télécom, marketed Wanadoo ADSL at prices which were well below variable costs until August 2001 and then significantly below total costs.
Since the mass marketing of Wanadoo ADSL began only in March 2001, the Commission considered that the abuse started only on that date. Wanadoo suffered substantial losses up to the end of 2002 as a result of this practice. The practice coincided with a company plan to pre-empt the strategic market for high-speed Internet access. From January 2001 to September 2002, Wanadoo’s market share rose by nearly 30 percentage points to between 65% and 75 % on a market which saw more than a five-fold increase in its size over the same period.
The abuse came to an end in October 2002, with a 30 percent reduction in wholesale prices charged by France Télécom.
Source: European Commission (staff analysis), Two Commission decisions on price abuse in the telecommunications sector, Competition Policy Bulletin, No. 3, Autumn 2003
Under the Areeda-Turner rule, prices must be below a firm’s short run marginal cost to qualify as predatory pricing. Recognizing that short run marginal cost is very difficult to measure, alternative short run measures of cost may be used (short run average variable cost, SRAVC, or short run incremental cost, SRIC).
Many economists promote the use of long run incremental cost (LRIC) as the appropriate cost threshold for predatory pricing. If two firms are equally efficient, they must have the same long run incremental cost. When one of them sets a price below LRIC, the other firm cannot match that price without incurring a loss.
Regardless of the measure used, calculations of firm-specific costs for individual services can be highly contentious.
Does the Firm Expect to Recover its Losses?
Many practitioners are skeptical about the prospect that a firm could know in advance all of the information needed to implement a predatory pricing strategy. In order to have a reasonable expectation that the strategy will succeed, the firm must know:
· How long it must price below cost before it succeeds in forcing its competitors out of the market,
· The size of the loss that it must withstand while predatory pricing is in effect, and
· The probability that it will recover its losses once it has achieved a monopoly.
Ex post antitrust remedies, such as fines or compensation, may be available for proven instances of predatory pricing. However, predatory pricing is difficult to prove with sufficient certainty to justify punitive measures.
A more useful remedy for predatory pricing is an appropriate price floor for the affected product or service. This is a preventive remedy, requiring ex-ante regulation.