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Predatory Pricing Introduction Pricing includes a variety of different problems relating to marketing, management accounting, planning, and economics. Proper usage of effective pricing models allows a company to raise its profitability of sales by avoiding and correcting erroneous pricing solutions. The development of pricing strategies is a task usually performed by top managers as a part of developing the general business strategy of a company. Successful pricing requires a good knowledge of the companys product range, its production processes, the list of main suppliers and customers, and information about the company's competitors. Having united the information and methods on marketing, business accounting, economics, business strategy, and product development, better results can be achieved in the complex process of pricing than while using each of these methods separately. This will help analyze the complex connection of the price, expenditures, and the production amounts.
This complex method is called the ABC (Action Based Costing) method. The establishment of a justified product price is impossible without a perfect knowledge of the expenditures. The justification for a price also depends on the companys understanding of the nature and dynamics of the customers demand and the character of the competition in the given segment of the market. The pricing methods dont give the manager an opportunity to affect the market market experience takes years to accumulate along with the research of the market demand and the circulation of the specific commodity in the given branch.
Intuition also plays a crucial role in successful pricing. However, there are companies that use the model of predatory pricing in order to survive at the modern market. The objectives of this project are to analyze various pricing models and methods and to introduce the predatory pricing. Finally, well draw conclusions and recommendations regarding the use of predatory pricing. Efficient Pricing is a Basis of Competitive Advantage Pricing is first of all a science, and knowledge remains its main instrument. The development of a successful pricing model requires exceptional creativity, but it is still a science just like management accounting, marketing, strategic management and economics all the scientific fields that constitute pricing.
The use of effective pricing models allows a company to raise the profitability of its sales by avoiding and correcting erroneous pricing solutions. The development of pricing strategies is a task usually performed by top managers as a part of developing the general business strategy of a company. However this does not mean that middle managers never get to make pricing decisions. Sometimes the corporate strategy supposes that the task of price policy formation be given to the middle management, while the top management only gives general recommendations on the issue. Successful pricing requires a good knowledge of the companys product range, its production processes, the list of main suppliers and customers, and information about the company's competitors. It is hard to find a single person with equally good competency in all of these fields, and therefore the most efficient pricing decisions can only be made in a group of managers representing different departments and divisions.
The abovementioned efficient exchange of information on price calculation is not established in many major companies. As a result, the analysts receive a set of various accounts and calculations from different departments made using completely different methods. Which one of them would be more realistic and / or effective? The main problem is that the analysts in separate divisions may omit or disregard vital information provided by their colleagues or be misinformed about the activity of other divisions. For instance, the production unit will be unable to make proper calculations on pricing without possessing correct accounting and logistics information, while the accountants cannot draw right conclusions on production spending without detailed knowledge of the manufacturing process and so forth. Then, to be able to make efficient pricing calculations the company's analysts must collect information from all the related divisions of the company.
Price competition diminishes inefficient manufacturers, driving them off the market and reducing the amount of supply, which in its turn sets a balance between supply and demand under a certain level of price, called equilibrium price. Profitable pricing requires a clear understanding of the connection between the sales amount and the cost per unit of production. First of all, the price of the item must be higher than its full production cost. The production cost of any product is constituted of fixed and variable costs. Many companies don't possess full and detailed information on their fixed costs. For example many manufacturers need additional spending to extend to the new sectors of the market and try the production of new goods.
Variable costs may also include general advertising spending and the salaries of some service personnel directly unrelated to the manufacturing process. Marketing costs, research and development (R&D) spending, engineering and product design and testing costs all of these costs are relatively constant and totally unrelated to the amounts of production and sales of the product. However the relation of cost on the amounts of production is much more complex in the real life manufacturing practice. The contemporary Costing methods use a complex multi-layered system of classification costs depending on the amount of production (fixed, variable and nominally variable), the objects of the costs (products, consumers, sales channels) and other cost-forming factors. In order to formulate a successful pricing strategy a company must first of all organize proper accounting on all the activity categories.
At the same time, some companies choose another way to lead price wars. One of them is called the Predatory Pricing Strategy. So, lets dwell on predatory pricing to understand the issue. The Predatory Pricing Strategy Definition: Predatory Pricing a pricing strategy based on temporary dumping of price. The strategy is to dump price till unprofitable level aimed to weaken or ruin the competitor. Paradox of predatory pricing is impossible to explain.
It is interesting to note that in case of equal expenses, the losses of predator will be much higher than losses of victim. Rational predatoriness can exist only in conditions of considerable imperfection of the market. Lets remember a suit against Microsoft Company (1998) to illustrate these words. The main accusations were as follows: Zero price for browsers; Exclusive contracting with internet provider America Online; Exclusive contracting with computer manufacturers; Tying and bundling. The company sold products with must-buy production (for example, Internet Explorer with operational system) As we can see, predatory pricing strategy is quite usual for big companies that want to win the market or to keep their positions.
For example, Russian economic market becomes more and more popular for foreign importers of steel products. Local manufacturers of stainless steel have merely lost the market during the competing war with foreign importers. They reduce ceiling of steel. At the same time import of rolled metal and cold-finished products increases. The company NCA Group (trademark iRU) stops to produce notebooks. NCA Group became the victim of predatory pricing strategy started by Chinese and Taiwan cheap manufacturers.
Brand iRU becomes a property of Million distributor and will introduce Chinese notebooks. The majority of businessmen consider that rich investor can afford himself to enter the new market without any profitability. What are the results of such wars? Consequences of Pricing Wars: Profits are Sensible to Dumping Lets derive main conclusions: Profits are extremely sensible even for minor decrease of pricing; Average structure of charges for large corporations are: marginal income (Price variable costs) = 29. 4 % Basing on such structure of expenses, 1 % reduction in price results in reduction in income 12. 3 % When pricing war occurs (with 5 % price reduction), the company should increase sales for 20 % to preserve the previous level of operational income. The Main Postulates of Predatory Pricing The strategy of predatory is aimed to force the competitor to leave the market.
Strategy can be used both by predator and victim company; The predator decreases price to force competitor to leave the market. Further, when the task is done, and the business is clean, he increases price; Predator usually decreases price below the level of variable costs and holds them until the competitor will leave the market; Predator incurs short-term losses to receive long-term advantages; The strategy can be successful only when the predator is able to keep low price longer than his competitors; Only strong companies with diversified markets and reliable sources of financing are able to hold predatory pricing strategy; In case the predator is able to bankrupt his competitor, he should become the owner of his competitors manufacturing feasibilities. In other case when the predator increases price in his branch of industry, competitors will try to use their manufacturing feasibilities Sometimes predatory pricing strategy is used to force competitor to sell his enterprise at low price. In such case predator can buy competitors manufacture at a low price and to become a monopolist. Sample Situation Lets assume that two enterprises have the same structure of expenses: the same curve of average costs (AC) and marginal costs (MC).
In case the company-predator wants to force his victim to bear losses and to leave the market, price in the industry should stop at level lesser than average costs (AC) (it means that price should be located in the interval of manufacture shutdown) In order to be successful in completing this operation, the predator should glut the market with his production and prices inevitably fall till level P . The condition is that the predator should be ready to supply the market with corresponding quantity of production till the level Q . In case the victim continues to sell his production, the victim supplies the market being based on rational considerations. The victim bases on level where the price is equal to marginal costs of manufacture Q 2 = MC This is still lower than average costs (AC).
The predator supplies the market with his production being based on difference Q - Q 2 = Q 1 In result of this operation the predator bears losses at the rate of rectangle A. The victim, in its turn, bears losses at the rate of rectangle B. As we can see from the table, in order to achieve success such strategy requires from the predator considerable resources. These resources are necessary to be able to bear significant losses during certain period of time supposed by the predatory pricing strategy. For example, Japanese companies pursued the same strategy when they wanted to win American markets (e. g.
Nowadays the majority of brands and companies that are manufacturers of TV sets belong to Japan). Action at Law Zenith vs. Matsushita (1986) American company-manufacturer of television sets accused seven Japanese companies of coordinated implementation of predatory pricing strategy; During more than 10 years prices for TV sets in the United States were approximately 60 % of its production price; Japanese corporations signed agreement aimed to decrease export price and limit distribution channels; Losses from sales of TV sets in the United States were financed from the military aid fund of the companies at the expense of monopoly price formation in Japan; The plaintiffs had to prove that in the final analysis predatory pricing strategy could increase the profits of company (test for profitability of predatory pricing strategy); The economists for the defense proved that decrease of price till 60 % of production price during 10 years is impossible to offset losses, therefore the judge has stopped the law suit. Modern Approach to Predatory Pricing Strategy at the Market: Rise in Expenses of Competitors Modern approach is based not on the decrease of prices but on rise in expenses of the competitors: Concluding exclusive contracts to make difficulties for competitors to access necessary capacities; Vertical integration upwards: monopolization of sources of raw materials and factors of manufacture to increase the costs of competitors at the lower levels of production chain; Massive advertising company: it increases the costs of competitors as well as the costs of the point of market entry; Numerous law suits against the competitors. Sample law suit because of increase of competitors costs: the creation of computer system of reserving and sale of airline tickets. Two first-rate airline companies of the United States United Airlines and American Airlines created the unified computer system of reserving and sale of airline tickets.
This system was programmed to prefer those two companies while making reservations and sales to the prejudice of all other companies that joined the system. The Ministry of the United States accused those two airline companies of vertical integration that is aimed to increase competitors costs and to receive market power. Export Dumping Definition: dumping is related to export sales at too law price. There are two standard approaches to definition of dumping by the World Trade Organization: Export sales of commodity at price that is lower than the price for commodity at local market (or at the market of a third country); Export sales of commodity at price that is lower than full average costs of manufacture (including profit margin) There are four reasons (varieties) for export dumping: Predatory dumping for liquidation of competitors; Cyclical dumping decrease in price during the period of business recession and / or depression with decrease in price lower than the price of average costs; Seasonal dumping sale of supplies / goods at lowered price at the end of the season. Such kind of sale is quite usual for production that doesnt have option of long-term preservation or production Persistent dumping so-called international pricing discrimination. Such dumping is possible when demand for production is less flexible at the local market than at the export market.
It can last during long period of time, as distinct from predatory and cyclical dumping. How to Protect From Predatory Pricing Strategy If the predator wants to enter a new market but at the same time he wants to avoid possible pricing war and losses, he can propose to the company that is already at the market, to unite their strategies. The united company can avoid the period of low prices and to establish high (monopoly) price for its production; You should try to conclude long-term contracts with your main clients if possible. In case of predatory pricing strategy rational customers should agree for concluding long-term contracts at price that is lower than monopoly price (the price that is for sure is established at the market when the main competitors of the company-monopolist will leave the market); The victim should shorten its manufacture as far as possible to minimize losses (during the period of predatory pricing strategy). It is recommended to redistribute manufacturing capacities for manufacture of other production.
When the period of predatory pricing strategy is over, the company will be able to re-enter the market Example: Lets assume the company manufactures tables for offices and dining-rooms. When the competitor starts pricing war in the segment of office tables, the victim should temporary focus its manufacture on dining-room tables. Predatory Pricing Strategy and Monopoly This problem is well-known to anti-monopoly authorities. The prohibition of such practice can be found in the articles of competition, where is claimed about the inadmissibility of the establishment of monopoly low prices.
Monopoly low price as well as monopoly high price can be determined through its comparison with competitive price. The problem of predatory pricing strategy as well as monopoly low prices is usually discussed as intermediate step towards the establishment of monopoly high price. This ratio is defined as follows: The dominating company establishes price for its production that is lower than average production costs. Such market situation leads to bankruptcy of its main competitors.
The predator company now is able to use the advantages of monopoly at the market. Consumers and Competitors From the consumers point of view, the main factor is their awareness of predatory strategy regarding the definite production. In case the consumers arent aware of predatory pricing strategy and / or are not aware of possible monopoly of the market, their actions will not bear strategic character. This situation doesnt make any changes to our analysis. In case the consumers are aware of predatory pricing strategy and / or are aware of possible monopoly of the market, their agreement to buy the commodity of a definite company will express their temporary consumer's preference.
Their gain in cost (in case they buy the cheaper production) at the present will inevitably be lesser than the losses from more expensive production in the future. In such a way, the consumers awareness either deprives the company of possibility to establish monopoly high price, or allows the company to continue the predatory pricing strategy and, in such a way, to increase consumer welfare. Now lets dwell on competitors. From the competitors point of view, the main factor is also their awareness of predatory strategy regarding the certain production. In case the competitors arent aware of predatory pricing strategy, they will possibly leave the market. The competitors can consider they are not able to effectively operate at the definite market.
Certainly, it will be a mistake. In case the competitor company is aware of predatory pricing strategy, but has to bear losses, it can focus attention on market of capitals. The success will depend on convincing argumentation of the company that proves the existence of predatory pricing strategy used by the other company. In case the company is able to survive after the implementation of predatory pricing strategy, it gains economic profit that will allow covering possible expenses related to credit operations. Moreover, the very possibility to receive credit can prevent the market from the beginning of pricing war or can result in alliance of competing companies.
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Research essay sample on Predatory Pricing Pricing Strategy
