predatory+pricing

=Preditory Pricing=

Bittle, Curtis
Preditory pricing is the practice of charging a low prices (below a product's Marginal Cost) in order to drive rivals out of business or create barriers to entry in a market.¹ ²

This is a pratice presumed to be used by large companies to create a monopoly. Smaller players have recourse in nations where this strategy has been outlawed.

Requisites for Preditory Pricing to exist:

 * 1) Companies using this strategy may need a hefty cash reserve, depending on the size the market and number of the companies is that you are trying convince to leave the market. Lowering price below Marginal Cost can mean losing money along with losing competition. Smaller companies should exit due to cost increases, but a large company may be able to ride the wave, creating a lose-lose situation (at least in the Short Run).
 * 2) The preditor's rivals must be significantly weaker financially.

Response for a company being preyed upon, to survive the attack:

 * Stop Production** - If a smaller company faces this strategy, stopping production will still incur fixed costs but no further variable costs. However, the preditor will loss money on both costs, as they are selling below Marginal Cost.

A flaw in the preditory pricing concept:
Although predatory pricing has been illegal in the United States since the Sherman Anti-trust Act in 1890³, there has not been a case of preditory pricing judged in the United States.¹ Microsoft is the center of just such a controversy.⁴

Example:
A company enters a new market and chooses to give their products away for free (or sell for very cheap--below Marginal Cost) as a promotion of their product and as a way to build company recognition.

This example is not an illustration of preditory pricing, although it meets some of the criteria (pricing below Marginal Cost). It is not deemed to be intended to eliminate competition. Rather it is considered a promotional strategy for entering the market segement. Unless it can be proved that a company is lowering costs with intent to create a monopoly, it is very difficult to condemn an organization with engaging in preditory pricing.

In contrast, the European Union has a more strict method for delineating predatory pricing behavior (See reference 5 for details). According to the European Union rules, if a firm is ruled by arbitrary measures to be dominant in a market, they are assumed to have intent when engaging in low pricing practices which can be shown to create barriers to entry or threaten firms which are not dominant.

Example 1:
In order to illustrate this concept we need to consider two firms, both established in the market segment. Firm A will be the preditor and firm B will be the prey that firm A wishes to eliminate from the playing feild. When firm A lowers its prices below Marginal Costs, firm B, being a small company, cannot support their product line, and so drop out of the market segment. Firm A incurred a short-term loss for the greater long-run profit. Firm B no longer exists (but they are taking legal action against firm A for violating the Sherman Anti-Trust Act.)

Example 2:
In order to illustrate this concept we need to consider two firms, both established in the market segment. Firm A will be the preditor and firm B will be the prey. When firm A lowers its prices below Marginal Costs, firm B, being a small company, decides to halt production. Firm A now has no incentive to continue producing at the lower cost because firm B halted production. As a result, firm A raises its price to avoid unnecessary losses, and firm B begins to produce the product again. Both firms take a short-term loss. This would be an example of the hit-and-run behavior that occurs with a Cournot Oligopoly or Duopoly.

**Questions**
1) For predatory pricing to succeed, a firm must: a) have more information on the market than competitors b) have the financial wherewithal to weather the period of low costing c) be a member of an existing oligopoly d) have a technology advantage over competitors

2) True or False: Competitive markets are excellent environments for preditory pricing to arise.

3) How many cases of predatory pricing have been succesfully tried in the United States? Explain.

4) What Act outlaws predatory pricing in the united States?

5) Which of the following is true? a) Preditory pricinig encourges entry into a market b) Preditory pricing does not effect the "preditor" c) The is no effective defense for preditory pricing for the "prey" d) Preditory pricing hurts all organizations in the industries profits

6) Why should a "prey" company stop production of a product if another company attempts to implement a preditory pricing strategy?

Answers
1) b 2) False. Competitive markets are unlikely to host preditory pricing. Markets with existing uneven power distributions are more likely environments for this form of predation. 3) None. This is due to the difficulty of proving intent. 4) The Sherman Anti-Trust Act 5) D - because if a company drops there sell price below MC all organizations in the industry suffer. 6) If a company stops producting they will only have the FC of operations. The VC of operations will become zero. This is important. The company will save income by not having any VC of operations to produce a product. The "preditory" will not have any competition left in the market and halt using the pricing strategy. When the competitor raise the sale price of the product above MC re-enter the market and continue producing.


 * References**

1. [|http://en.wikipedia.org/wiki/Predatory_pricing.] 2. Baye, M. R. (2006) //Managerial Economics and Business Strategy.// New York, NY: Mcgraw- Hill Irwin 3. http://www.stolaf.edu/people/becker/antitrust/statutes/sherman.html 4. http://www.businessweek.com/1998/47/b3605129.htm 5. http://ec.europa.eu/comm/competition/speeches/text/sp2003_066_en.pdf