Predatory Pricing
Predatory pricing is the practice of selling a product or service at a very low price, with the intention of driving competitors out of the market, or create barriers to entry for potential new competitors. Since competitors cannot sustain equal or lower prices without incurring losses, they may be forced out of business. After chasing competitors out of the market, the incumbent would have fewer competitors (and may in fact be a monopoly), and can then - in theory - raise prices above what the market would otherwise bear.
In many countries, predatory pricing is considered anti-competitive and is illegal under competition laws. However, It is usually difficult to prove that prices dropped because of deliberate predatory pricing rather than legitimate price competition. In any case, competitors may be driven out of the market before the case is ever heard. Thus, many economists are doubtful that the concept of predatory pricing is actually practical and transferable to the real world.
Economic Rationale
In the short run, profits for the incumbent will fall due to predatory pricing, possibly even into negative territory. The incumbent will not mind so long as they can maintain these losses, which can be made up for once they raise prices above the would-be market level: after the weaker competitors are driven out, the surviving business can raise prices above competitive levels (to supra competitive pricing). The predator hopes to generate revenues and profits in the future that will more than offset the losses it incurred during the predatory pricing period. There must be substantial barriers to entry for new competitors for predatory pricing to succeed. But the strategy may fail if competitors are stronger than expected, or are driven out but replaced by others. In either case, this may force the predator to prolong or abandon the price reductions. The strategy may fail if the predator cannot endure the short-term losses, either because it takes longer than expected or simply because the loss was not properly estimated. So the predator should hope this strategy to works only when it is much stronger than its competitors and when barriers to entry are high. The barriers prevent new entrants to the market replacing others driven out, thereby allowing supra competitive pricing to prevail long enough to dwarf the initial loss.
Criticism and Support
Criticism
Some economists claim that true predatory pricing is rare because it is an irrational practice and that laws designed to prevent it only inhibit competition. This stance was taken by the US Supreme Court in the 1993 case Brooke Group v. Brown & Williamson Tobacco. The Federal Trade Commission has not successfully prosecuted any company for predatory pricing since. Economists argue that the competitors (the 'prey') know that the predator cannot sustain low prices forever, so it is essentially a game of chicken. If they can ride it out, they will survive. And even if they cannot, bankrupcy does not by itself eliminate the fallen prey's ability to produce: the physical plant and people whose skills made it a viable business will exist, and will be available - perhaps at very low prices - to others who may replace the fallen prey once supra-competitive prices set in.Critics of laws against predatory pricing may support their case empirically by arguing that there has been no instance where such a practice has actually led to a monopoly. Conversely, they argue that there is much evidence that predatory pricing has failed miserably.
Support
Prey may not see it as a game of chicken, if they truly believe that the prey has actually found a way to achieve a lower cost of production than them. Thus, they would not know predatory pricing is occurring. They would exit the market, thinking it is no longer profitable. This is known as 'low-cost signalling'. However, this does not support the idea that the new virtual monopoly could raise and sustain prices at monopoly levels, even though there are certain barriers to entering monopolized markets that could, in theory, prevent the entry of competition.
Examples
According to an International Herald Tribune article, the French government ordered Amazon.com to stop offering free shipping to its customers, because it was in violation of French predatory pricing laws. After Amazon refused to obey the order, the government proceeded to fine them €1,000 per day. Amazon continued to pay the fines instead of ending its policy of offering free shipping. Low oil prices during the 1990s, while being financially unsustainable, effectively stifled exploration to increase production, delayed innovation of alternative energy sources and eliminated competition from other more expensive yet productive sources of petroleum such as stripper wells. It is important to note that in both these and other cases, the predatory pricing policy is alleged, and difficult to prove comprehensively.
Oil refinery
Low oil prices in the 1990's were considered a case of alleged predatory pricing.