Strategic Entry Deterrence - Predatory Pricing

Predatory Pricing

In a legal sense, a firm is often defined as engaging in predatory pricing if its price is below its short-run marginal cost, often referred to as the Areeda-Turner Law and which forms the basis of US antitrust cases. The rationale for this action is to drive the rival out of the market, and then raise prices once monopoly position is reclaimed. This advertises to other potential entrants that they will encounter the same aggressive response if they enter.

In the short run, it would be profit maximizing to acquiesce and share the market with the new entrant. However, this may not be the firm's best response in the long run. Once the incumbent acquiesces to an entrant, it signals to other potential entrants that it is "weak" and encourages other entrants. Thus the payoff to fighting the first entrant is also to discourage future entrants by establishing its "hard" reputation. One such example occurred when British Airways' engaged in a competition war with Virgin Atlantic throughout the 1980s over its transatlantic route. This led Richard Branson, chairman of Virgin Atlantic, to say that competing with British Airways was "like getting into a bleeding competition with a blood bank."