Predatory pricing is a pricing strategy used by dominant businesses with significant market power, that involves the deliberate lowering of prices in order to damage or eliminate competition. Smaller firms in the market would not be able to match and sustain the lowered prices without substantially narrowing their profit margins or even incurring a loss. Due to this, predatory pricing is characterised as a misuse of market power.
Difference Between Predatory Pricing and Competitive Pricing
Lowering the price of your product to compete with other firms in the market and subsequently increase sales does not necessarily equate to predatory pricing. In fact, lowering prices for this reason is called competitive pricing. The difference between predatory pricing and competitive pricing lies largely in motivation; competitive pricing is driven by wanting to compete with other firms whilst predatory pricing is driven by wanting to damage or eliminate competition.
Impact of Predatory Pricing
Whilst it may seem as if consumers actually benefit from predatory pricing due to the lower prices, this is only in the short term. Once the desired effect of damaging or eliminating competition comes into play, the dominant firm remaining gains even more market power and has the ability to raise prices to much higher levels than necessary to bolster profit and make up for any lost profit prior.
In doing so, consumers in the medium to long term have no choice but to pay the higher prices as prior competing firms have been damaged or eliminated and even potential firms are deterred from entering this market due to the anti-competitive signal given by the remaining firm(s).
This may actually lead to a market structure called a ‘monopoly’ which occurs when there is only one seller/firm in the entire market for a product. Such a market structure reduces the incentive to innovate as dominance and streams of revenue are almost guaranteed irrespective of innovative processes and operations.
Innovation is an important driver of productivity which in turn places upward pressure on economic growth and economic activity and thus, a lack of innovation can actually stifle or at least slow the two.
Legality of Predatory Pricing
In light of the above, Predatory Pricing is understandably illegal as per the Competition and Consumer Act 2010 (CCA). Subsection 46(1) of the CCA prohibits market power misuse and requires two elements to be satisfied in order for the provision to be applicable; that the corporation at hand has a substantial level of market power and that the corporation actually takes advantage of this power.
Interestingly, the relatively new provision of subsection 46(1AAA) stipulates that if a corporation supplies goods and services at a price less than the cost the corporation incurs and that price is kept for a sustained time period, subsection 46(1) may be contravened.
The legislation also makes a slight distinction between corporations that have substantial market power and corporations that have substantial share of the market yet corporations with substantial market share are still prohibited from engaging in the conduct outlined in the above paragraph as per subsection 46(1AA). Market power refers to the ability of a firm to determine market price and market share is the percentage of total sales in a market generated by the firm at hand but the two tend to go hand in hand; many firms with market power tend to make up a large market share and vice versa.
Predatory pricing is a commercial strategy that involves a dominant firm with market power cutting the prices of their products in order to damage or eliminate competitors. Once this is successful, the remaining firm has even more market power than before and then has the ability to extensively raise prices and consumers are left having to pay such prices. Due to the range of ramifications that predatory pricing yields, it is illegal according to the Competition and Consumer Act 2010.
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