Predatory pricing takes place when a deliberately low price is charged in an attempt to lever out some of a firm's competitors from the market. When aggressive price cutting is used to deter competitors or to try to push competitors out of the market, this approach is known as destroyer pricing. The aim is purely and simply to 'destroy' the competition. Normally the price reduction is temporary, because the low price may not be profitable. This strategy may be perceived as anti-competitive by the government regulators.
Another strategy that might be used is deterrent pricing, which is where a company keeps its prices as low as possible as a barrier to entry. Potential rivals may be dissuaded from entering the market as they fear they cannot earn sufficient returns.
So when might predatory pricing be appropriate?
To be able to use a predatory pricing strategy effectively, a firm will need to consider:
- The financial strength of the firm - predatory pricing techniques will mean much lower (or even negative) margins, so the firm will require the financial reserves to be able to cope with this.
- The financial strength of competitors - how financially secure are the firm's competitors? The greater the reserves they possess, the longer they will be able to hold out and match the lower prices.
- The importance of price - what is the price elasticity of demand for the product? If the price elasticity of demand is very low (i.e. the product is price unresponsive) then a lower price will not be a significant factor in persuading people to switch from other firm.
- The strength of the brand and competitor's brands - if competitors have strong brands, then this will make it more difficult to persuade consumers to switch away as a result of lower prices.