When you're trying to attract price-conscious consumers, it's counterintuitive to think of a price as being "too low." Pricing below your competitors, or even below your own costs for a period, can help your business to win new customers and gain market share. Problems arise when a company prices so low that competitors quit, clearing the way for the predator company to raise prices in the long run.
TL;DR (Too Long; Didn't Read)
Predatory pricing is the dubious and potentially illegal strategy of pricing your products at a very low price to drive competitors out of the market.
Predatory Pricing Explained
A pricing strategy is said to be "predatory" when a company reduces prices to a level below its own costs with the intention of driving its rivals out of the market. After the predator has attained a dominant market position, it is free to raise prices to whatever level it wants, recoup its losses, and potentially make higher than normal profits far into the future. Predatory pricing is illegal under antitrust laws. Ultimately, it gives the predator monopoly-like powers and deprives consumers of the benefits of long-term price competition.
Undercutting Versus Predatory Pricing
There's nothing wrong with pricing a product very cheaply for a period. For many businesses, undercutting is a sensible strategy for attracting new customers and increasing market share, even if it involves incurring a temporary loss. Regulators take the view that, in most markets, it's unlikely that one firm could price unrealistically low long enough to drive out a significant number of rivals. It's only when your pricing strategy is part of a deliberate plan to damage competitors that it may fall afoul of the law.
Predatory Pricing Examples
In one textbook case that went before the regulators, the monopoly cable TV system operator in Sacramento drastically cut its prices when two smaller rivals attempted to enter the California market. As a result, the rivals could no longer sign up the number of customers they needed to break even and were forced to shut down their operations after just eight months; one company lost a non-salvageable $5 million investment. Following the competitors' exit, the predator promptly withdrew the discounts it had offered customers. By its own estimate, this predator avoided losses of around $16.5 million per year against a predatory expenditure of just $1 million.
Problems for Regulators
The early signs of predatory pricing are actually procompetitive, so the practice is difficult to spot. For example, a supermarket might sell some items like bread at a deep discount to attract customers while maintaining regular pricing on its other products, or a company might gradually lower the price of a product during a price war. From the regulators' perspective, a company needs to do more than just sell low to drive out rivals. It must put itself in a position where rivals cannot re-enter the market once prices rise to supra-normal levels before the Federal Trade Commission will move forward with enforcement.