Low Prices Can Be Anti-Consumer

Monday, February 9, 2015

Many companies are known their low prices. These firms usually decide to to offer their wares with tiny pricing markups. Occasionally they become even more aggressive and sell their products at a loss. Most consumers would probably be overjoyed to be on the receiving end of either of the above scenarios. After all, why would anyone want to spend more than he has to for a given product?

All consumers benefit initially from super-low pricing, yet (in the long-term) consumers will almost certainly be harmed. The classic example of a predatory firm that used low prices to harm consumers is Standard Oil Company. It was famous for selling oil at low prices that often dipped below the cost of production. Why would anyone (other than the firm's shareholders) be upset by this practice?

Standard Oil sign
Image courtesy of Pat Hawks

Low prices are just the first step in a predictable sequence of actions:

  1. A large firm lowers its prices to an absurd level
  2. Competitors go bankrupt or decide to leave the market
  3. The remaining firm increases prices

The third phase is key. With no competitors to challenge the remaining firm, prices will rise far above the original market rate. The resulting possibility for oversized profits incentivizes many players with large bankrolls to follow this very script. Not only can they use their funds to destroy more efficient competitors (firms that have lower production costs), but the mere threat of pursuing this strategy can and will dissuade new competitors from entering the marketplace at all. The result is always the same: higher prices for consumers.

While most small firms don't have the resources to implement predatory pricing successfully, larger firms must be carefully watched to ensure that they won't use their resources to unfairly destroy the competition.

Want to learn more about how pricing works? Then take a peek at my software pricing guide or contact me for a private consultation.