Preventing the business from predatory pricing operators

In telecom, we refer to predatory pricing as the practice of selling a telecom product or service at a very low price, intending to drive competitors out of the market, or create barriers to entry for potential new competitors. If competitors or potential competitors cannot sustain equal or lower prices without losing money, they go out of business or choose not to enter the business. The predatory operator then has fewer competitors or is even a de facto monopoly, and hypothetically could then raise prices above what the market would otherwise bear.

In the short term predatory pricing through sharp discounting reduces profit margins, as would a price war, and will cause profits to fall. Yet operators may engage in predatory pricing as a long-term strategy. Competitors who are not as financially stable or strong may suffer even greater loss of revenue or reduced profits.

After the weaker competitors are driven out, the surviving operators 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.

In essence, the predator undergoes short-term pain for long-term gain. Therefore, for the predator to succeed, it must have sufficient strength (financial reserves, guaranteed backing or other sources of offsetting revenue) to endure the initial lean period. There must be substantial barriers to entry for new competitors.

But the strategy may fail if competitors are stronger than expected, or are driven out but replaced by others. In either case, this forces the predator to prolong or abandon the price reductions. The strategy may thus fail if the predator cannot endure the short-term losses, either because of it requiring longer than expected or simply because it did not estimate the loss well.

So the predator should hope this strategy to succeed only when it is substantially 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.

How can competitors react to predatory pricing?

As referred, predatory pricing polices normally set prices below marginal costs or some other measure of costs in order to drive a competing operator out of the market or to deter its entry in advance. Is there any pricing tool as a superior alternative to standard cost-plus pricing or average cost markup rules? YES there is: elasticity pricing.

Pricing elasticity on demand or demand elasticity measures the relation of price and demand for a certain tariff / product, looking for an optimal price level. The optimal price level is found where the marginal cost is equal to the marginal revenues – the price point where an additional minute does not generate any additional marginal profit and does not improve any critical KPI.

We have selected some illustrative slides to detail our point of view on pricing elasticity and pricing optimization, based on our experience in not only mature markets like the European but also emerging and highly competitive markets such as the African or Asian markets.

Enjoy the reading! CVA

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