Predatory pricing is a particular form of price discrimination where a market-dominating firm charges below-cost prices for some goods or in some areas in order to drive out or discipline one or more rival firms. Eventually, the predator hopes to raise prices and earn back enough profits to compensate for the losses during the period of predation. The firm challenging prices as being predatory bears the burden of proving three things:
- The predator has significant market power;
- The predator prices some goods at least below its total costs, including an allocation for overhead costs for a significant period (some courts require prices to be below variable costs, which for retailers would probably be the cost of merchandise without any allocation of overhead); and
- There is a reasonable likelihood that the predator will be able to recoup its predatory losses. Some states have old statutes that declare it illegal to sell merchandise at unreasonably low prices, usually below their cost. However, a retailer generally may sell merchandise at any price so long as the motive isn’t to destroy competition.
Example: Independent retailers in small towns have long accused Wal-Mart of selling goods below cost to drive them out of business and then boosting prices after seizing control of the local market.
Wal-Mart maintains that it hasn’t violated the law because it didn’t intend to hurt competitors. But it admits it has sold some products below cost, as do other retailers. These loss-leader products are intended to attract customers into the store where it is hoped, they will then buy other products that are priced to be profitable. Wal-Mart claims its loss leaders are part of its everyday low price strategy. More competition leads to lower prices, while less competition leads to higher prices. Wal-Mart’s so-called predatory pricing strategy has been tested in the courts. After an early conviction in a lower court, the Arkansas Supreme Court ruled that the chain had no intent to destroy competition through its practice of selling a revolving selection of prescription and nonprescription drugs at less than cost. In essence, the Arkansas Supreme Court distinguished loss-leader pricing, even by a firm with market power, as a legitimate competitive tactic from predatory pricing.