In 2010, Diapers.com gained momentum with its combination of e-commerce and pricing. Rumours report that Amazon previously tried to buy the diaper supplier but was denied. Afterward, Amazon aggressively lowered prices on diapers and related products.
Such tales are related to predatory pricing, a pricing strategy waged by suppliers to gain an edge on competitors.
In this guide, you’ll learn:
- What’s predatory pricing?
- Is predatory pricing illegal?
- What are the advantages and disadvantages of predatory pricing?
- Ways to compete against predatory pricing and gain e-commerce sales
What Is Predatory Pricing?
Predatory pricing seeks to undercut the competition as part of a larger pricing strategy. While the pricing decision creates short-term losses, the main agenda is to debilitate the competition. Ultimately, a brand introducing predatory pricing makes rivals economically vulnerable, so it gets increasingly difficult for smaller businesses to compete and ultimately exist.
A newfound market share makes the initiator of predatory pricing in an economic position to recoup the losses sacrificed. So, predatory pricing is recognised as a two-part process, beginning with a predation phase then leads to a period of economic recovery and eventual dominance.
Economic scholars recognise predatory pricing’s first stage of predation as when a brand initially offers a good or service at a below-cost rate. A small-scale strategy by a startup will not influence market price. However, a big supplier can effectively influence market costs with its pricing strategy.
Predatory pricing works for large firms because such suppliers can sustain the losses long enough to change the market price (and behaviour of consumers), ultimately depressing the competition’s ability to keep-up or compete at all.
In the second stage, the dominant brand reaches a state of equilibrium, readjusting prices now that a larger share of the market is taken or a rival is no longer able to compete. The recoupment phase is where economists make the distinction between predatory pricing and competitive pricing.
Predatory Pricing vs Competitive Pricing
Regardless of intention, all brands seek profits, but predatory pricing differs from competitive pricing. Predatory pricing does not reach equilibrium once market share is gained and the competition defeated. While competitive pricing can benefit the consumer, in the long run predatory pricing only serves to benefit the perpetrator. Once dominance is reached, predatory pricing takes effect and a monopoly becomes a reality.
Predatory pricing only benefits the seller - the reason why it is illegal under many laws. However, in practice, it’s somewhat opaque to distinguish competitive from predatory pricing - even in courts of law.
Examples of Predatory Pricing
In 2010, Amazon, a growing giant of ecommerce, engaged in a price war with Diapers.com, a niche competitor that quickly gained popularity and revenue. Rumours circulate that Amazon tried to acquire Diapers.com but was denied.
Afterward, Amazon aggressively lowered prices on diapers and related products. Furthermore, Amazon introduced more ways for customers to save on related products; it launched Amazon Mom, featuring cashback, free shipping, and more discounts.
However, predatory tactics do not always prove successful. In a bromine price war, American-based Dow Chemical gained presence within the European market. An established Euro-brand sought to “punish” Dow by offering bromine at below-cost prices to Americans, hoping to ruin Dow’s chances of making profits within its home market. Unfortunately for the European brand, Dow took advantage of that lower cost, bought low, then sold it back to the European market at a profit.
Another tale of predatory pricing gone awry involves the New York Central Railroad. In an attempt to outdo Erie Railroad, the NYCR charged a mere dollar per car for cattle transportation. However, the newfangled trend benefitted the Erie Railroad too, for it also began hauling cattle.
Is Predatory Pricing Illegal?
True predatory pricing is seen as a means to a monopoly. The United States has a history of recognising and punishing predatory pricing. Antitrust laws seek to foster healthy competition while thwarting opportunity for monopolistic business practices. According to American antitrust laws, most “forms” of predatory pricing are illegal.
Predatory practices are recognised as instruments of corruption and greed. However, where does greed stop and the need for competition begin within a system that ultimately seeks profits?
The Federal Trade Commission seeks to fully analyse any claims of predatory pricing. Moreover, the US Department of Justice recognises predatory pricing as a problem, growing increasingly aware of the unscrupulous pricing strategy.
It can be difficult for plaintiffs to make objective claims that hold in court. Successful antitrust suits are based on a plaintiff clearly establishing that a competitor’s pricing will condemn rivals as well as cause a direct and negative impact throughout the market as a whole.
Furthermore, US courts define predatory pricing as that “set below a seller’s cost.” However, it is not against the law for a seller to set prices in such a manner if the reason is justifiable and not perpetrated to directly eliminate competition or ultimately monopolise the market.
If pricing is set below cost for legitimate purposes, such as to attract a larger portion of the market, it is not predatory pricing. “Catching” a brand waging a potentially unscrupulous pricing strategy is delicate practice. For example, penetration pricing could look and feel like predatory pricing to a rival. However, if the pricing strategy is short-lived and not a long-term plan, it is not illegal and deemed “fair play” within the world of business.
The Effects of Predatory Pricing
While unlawful conduct is a black-and-white issue, pricing strategy remains somewhat of a murky area. One’s interpretation of “predatory” could be another’s version of “smart business.”
Economic theories see possible advantages to predatory pricing. For one, predatory pricing may become a “survival of the fittest” regarding the brands within a given market. While buyers may initially be interested in price points, some argue that price alone will not condemn inferior products and services. Therefore, predatory pricing is merely a speedier means to an end of greater selection for consumers.
Furthermore, some see the exit of particular brands as an invite for new and innovative brands to enter the marketplace, challenging behemoth competitors in new ways that ultimately serve the greater good of the market and consumers.
Lastly, in regards to seasonal items or perishable goods, predatory pricing may help a brand in a short-term predicament of needing to clear shelves for more stock or to sell items before selling them at all is no longer an option.
On the other hand, taking competitive pricing too far becomes illegal depending on government jurisdiction. Therefore, any brand willing to wager a predatory pricing strategy runs the risk of legal repercussions and attracting legal suit.
Furthermore, predatory pricing does not escape the perception of consumers. In some cases, aligning your brand with “cheap” prices could have a negative effect. An overall impression of frugality may turn some consumers away. In worse scenarios, consumers view your brand as a selfish, predatory entity, ultimately existing to gain the most profit regardless of what’s best for the market or its consumers.
Advantages of Predatory Pricing
- Provides an opportunity to overcome barriers in entering a new market. For those already with market share, it may prevent rivals from entering a market.
- It exposes rivals to economic vulnerabilities. A competitor that is unevenly regarding economic risk, invites the possibility of greater devastation if they cannot amass market share.
- Predatory pricing invites the potential for total market dominance once it effectively changes consumer perception and behaviour.
Disadvantages of Predatory Pricing
- It attracts potential lawsuits or deemed illegal, depending on jurisdiction
- Brands using predatory pricing run the risk of ultimately losing money if the minds of consumers are not affected or monies lost in the initial phase are not compensated in the recoupment stage.
- In some cases, a predatory pricing brand may be sowing the seeds for a rival’s eventual return to market, for at times, defunct resources can be renewed. For example, the Washington Post went bankrupt in 1933 only to later become the biggest newspaper in Washington.
Predatory Pricing in the Present - A Look at Amazon
It’s difficult to pinpoint how dominant Amazon is regarding ecommerce, but it’s estimated that it accounts for 40% of US retail sales (Some believe the market share is somewhere closer to 50%.)
Many smaller brands find it undeniably necessary to access Amazon’s Marketplace, with some estimating the marketplace is the sole source of income for a whopping 37% of its third-party suppliers.
Moreover, Amazon’s marketplace is not the only place the company reaps profit. Amazon Web Services, offering cloud resources, also adds to its coffer. Amazon’s share within the infrastructure market amounted to 33% for the second quarter of 2020. That’s equal to the combined share of three of its largest competitors.
As with goods purchased on the Web, the pandemic has not had a negative impact on Amazon’s ability to sell. Cloud infrastructure service revenues eclipsed $30 billion in the second quarter of 2020.
There’s no debating that Amazon can easily afford to cut prices in the short-term in exchange for ultimate dominance. Amazon can influence prices, consumer behaviour, and the existence of the competition.
Many businesses understand that you don’t beat Amazon. You join them. However, a number of strategies help smaller brands compete in niches and make headway in particular ecommerce markets. Here’s how they are keeping up with ‘the Amazons’ of the business world.
Ways Businesses Compete with Predatory Pricing
Many entrepreneurs and small business owners want to make money, but they want to do it by building a reputable and longstanding business model. While no brand is going to be sad about debilitating the competition, most find legitimate and law-abiding ways to success.
Starbucks coffee isn’t cheap but that doesn’t stop its penetration of the coffee market, reaching a net revenue of $26.5 billion in 2019. It sees year-over-year increases for the last decade. There was once a time when consumers would certainly balk at Starbucks price point. Now, they can’t seem to resist taking out their wallets regardless of the attached price.
What’s the economic benefit of retaining existing customers versus taking the marketing risk at attracting new ones? According to research, 58% of customers switch brands. For many, retaining customers is less costly than acquiring new ones.
Do what you can to express appreciation to existing customers, for there’s a 70% chance of selling to a repeat customer. However, those odds drop as low as 5% when attempting to sell to a new one.
Search engine optimisation is no secret weapon. It’s an undeniable component of digital marketing strategy. Ensure your site’s pages are optimised for targeted keywords. This requires strategic keyword research, effective product descriptions, as well as paying attention to user experience and site architecture.
The first organic result aligned with a Google search has an average click-through rate of 28.5%. And, the average CTR falls dramatically after position one. A study found the second result to get a 15% CTR, and the third, 11%. By the time a user gets to the tenth result or estimated bottom of the first page of results, the CTR drops to 2.5%.
How are your website visitors behaving? An analysis of analytics can reveal insights related to the sales funnel. A study finds that about half of ecommerce visitors look at product pages but only about 15% add items to site shopping carts. However, a mere 3% actually go ahead with the finalisation of purchase.
Target troublesome areas of the sales funnel, identifying needs for improvement and finding why some consumers are not buying from you. As mentioned, only 3% buy what’s loaded in their cart. What’s the reason for your shopping cart abandonment?
We live in a world of online shopping and online shoppers don’t like added costs. Therefore, added costs, such as cost of shipping, remains a top reason for shopping cart abandonment. An additional percentage of customers abandon carts after finding the delivery will take too long.
9 out of 10 customers agree that free shipping is a premier incentive. 93% of online buyers will buy more if free shipping is an option. Moreover, 58% add more items to a cart to qualify for free shipping.
A consumer survey reveals that 82% identify price as a very important reason for making a purchase. Low shipping costs come in second as 70% of respondents find it important. Therefore, there is no denying that pricing is a main concern for smaller ecommerce brands that compete with online competitors like Amazon as well as need to combat the ROPO effect (researching online but purchasing offline).
Yes, there is no denying the importance of pricing. However, implementing a pricing strategy proves difficult for many suppliers who lack the resources and time for proper devotion. Yet, some have adopted dynamic pricing software, an automated way to set prices and stay competitive.
Predatory Pricing vs Dynamic Pricing
Automated pricing software allows for a dynamic way to go about cost strategy. What if a business could apply a dynamic pricing strategy at scale, regardless of offered goods and services?
Dynamic pricing’s algorithm provides an agile way to implement pricing. Gather data and enjoy the freedom of setting prices at a rate that works best for your company’s short and long-term goals.
Automated pricing software allows for your company to set pricing standards. Implement your own “pricing rules” and get as general or as granular as you would like regarding every product or service offered.
Automated pricing software accounts for each product and service offered, so the price of each item appropriately compensates for sales volume, number of items, time of day, etc. Every product is considered and automatically assorted according to optimal price.
Total automation allows for complete pricing analysis of the market, including competitor pricing. Dynamic pricing software gathers competitor data, internal metrics, market prices, consumer behaviours, and then provides optimised price suggestions.
Dynamic pricing software does not work in isolation, making pricing suggestions based on mysterious precedents. The software provides reasoning for price suggestions, so users can grow market awareness as well as manually override when they see fit.
Predatory pricing is an illegal practice but it would be naive for smaller and burgeoning ecommerce businesses to deny predatory-like behaviours exist. Given the growing popularity of ecommerce and its explosion over the last decade, established and new brands need the knowledge and tools to compete with Amazon, Target, and Walmart as well as local vendors.
In the short-term, predatory practices and giant competitors, like Amazon, are not going away. If you’re not going to beat them, then you must find a way to join-in and “match” competitors. Solutions such as dynamic pricing software level the field of competition and help small ecommerce brands succeed regardless of the size of rivals and aligned pricing strategies.
Other Pricing Articles:
Sander Roose isn't just a business Founder and CEO - he's a proud father of two, a sports enthusiast, and a serial entrepreneur. He holds an MSc degree in Industrial Engineering & Management Science from the Eindhoven University of Technology, where he graduated cum laude. With two decades of retail and eCommerce experience, working on the retail side of Procter & Gamble, to specialising in retail strategy consulting at Harvest and Commerce Squared. Sander loves puzzling through retail’s most significant pricing and market challenges by combining strategy, AI and technology. As CEO, he sets the course for Omnia and guides the company through strategic changes and growth.