Predatory pricing is a practice in which a company attempts to gain control of a market by cutting its prices to levels well below those of competitors, so that those competitors go out of business because they cannot match those prices, or they cannot sustain lowered prices because they lack capital. This tactic is illegal in many regions of the world, although it can be very difficult to prove that a company is really engaging in predatory pricing. Some economists have suggested that this practice is largely theoretical, and that very few companies have actually engaged in it.
In order to use predatory pricing as a business tool, a company has to be strong enough to take a loss for an extended period of time on the products it is selling at low cost. Many companies lack the financial backing to do this, which can make this tactic a risky gamble. Companies must also rely on the assumption that competitors will not return to the market once prices are raised to more normal levels.
This practice works in a number of ways. Predatory pricing typically keeps new competitors out of the market, because they cannot hope to match the artificially low prices which have been created, and the practice also drives existing companies out of the market by lowering prices beyond a point that which they can match. In some cases, a company may drive other companies out of business and then acquire their facilities, employees, and/or equipment to prevent them from getting back into the industry.
One of the classic examples used to illustrate predatory pricing is that of a chain coffee shop which opens across the street from a locally-owned coffee shop. Theoretically, the prices at both shops should be similar, because the base expenses for coffee, pastries, and other products will be similar. However, the chain can rely on its corporate backing for support and make the decision to radically lower prices, attracting customers to its facility and eventually driving the competition out of business.
Critics of the predatory pricing theory argue that companies which appear to be engaging in this practice are really just competing openly and fairly in the market. In the example above, for instance, the chain coffee shop is not doing anything illegal, it’s just making a calculated business decision to capture more of the market share, relying on the resources it has to support it through several months when income may be a little lower than desired.