Predatory Pricing
What is Predatory Pricing?
Predatory pricing is cutting price below cost to drive rivals out of a market, with the plan of raising price once the competition is gone.
Predatory pricing runs in two stages. In the sacrifice stage the firm sells below its own cost and absorbs losses that a rival with shallower pockets cannot match; in the recoupment stage, once the rival exits, it raises price and earns back more than it lost. The whole plan collapses without barriers to entry, because a high post-exit price simply invites a fresh competitor and the predator never recovers the money. That is why economists have long argued predation is rarer than it looks, and why courts usually demand proof of both below-cost pricing and a realistic path to recoupment. Aggressive discounting by a firm that genuinely has lower costs is not predation; it is the competition the law exists to protect.
Predatory Pricing: a worked example
A large chain faces a single local rival. Its average variable cost is $5, but it prices at $3 and sells 200,000 units, absorbing a loss of (5 - 3) × 200,000 = $400,000 over the year. The rival cannot fund losses that size and closes. The chain then raises price to $9 and sells 250,000 units at a $4 margin over the same $5 cost, or $1,000,000 a year, recovering the $400,000 in under five months. The plan only pays if something stops a new competitor from opening once the price reaches $9.
The mistake students make with predatory pricing
Students label any price war or any very low price predatory. Selling cheaply is not predation; the price has to be below the seller's own cost, meaning the seller is deliberately losing money on every sale. The second slip is stopping at the loss stage and forgetting recoupment. Without barriers to entry there is no way to raise prices afterward, so the whole exercise would be a gift to consumers.
Predatory Pricing questions
Is predatory pricing illegal?
Predatory pricing can violate antitrust law, but a claim generally has to show both that the price was below an appropriate measure of the seller's cost and that the seller had a reasonable prospect of recouping the loss later. Courts set that bar high, because low prices normally help consumers.
Why is predatory pricing hard to prove?
Predatory pricing is hard to prove because below-cost pricing looks identical from the outside to ordinary aggressive competition by a low-cost firm. Establishing it requires knowing the seller's true costs, which are private, and showing that entry barriers would let the seller raise prices after the rival exits.
What is recoupment in predatory pricing?
Recoupment is the second stage, in which the surviving firm raises price after its rival exits and earns back the money it lost while pricing below cost. If entry is easy, recoupment fails, and a strategy that cannot recoup is simply irrational rather than predatory.
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