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Entry Preventing Pricing Strategies
Introduction
In markets with high competition, existing firms often use entry-preventing pricing strategies to discourage new firms from entering. These strategies help incumbents maintain market power and avoid losing market share.
This blog explores key entry-deterrence pricing strategies, including limit pricing, predatory pricing, and strategic barriers to entry.
1. Limit Pricing
What is Limit Pricing?
🔹 Limit pricing refers to setting the price low enough to discourage new entrants while still allowing existing firms to earn profits.
🔹 First introduced by Bain (1956), this strategy works when potential entrants believe they cannot earn enough profits at that price.
✔ Incumbent sets price below the new firm’s average cost.
✔ New firms see no profit opportunity and stay out.
✔ Incumbent firms continue to dominate the market.
Graph: Limit Pricing Strategy
(Illustration showing how the incumbent firm sets a price below the entrant’s average cost, preventing market entry.)
Example: Amazon’s Pricing Strategy
📌 Amazon often offers deep discounts, making it difficult for smaller e-commerce firms to enter.
2. Predatory Pricing
What is Predatory Pricing?
🔹 Predatory pricing involves setting prices below cost for a temporary period to drive competitors out of the market.
🔹 Once rivals exit, the firm raises prices to recover losses.
✔ Prices set below marginal cost to hurt competitors.
✔ Competitors exit the market due to unsustainable losses.
✔ Firm later raises prices to monopolistic levels.
Example: Walmart vs. Small Retailers
📌 Walmart has been accused of aggressive discounting that drives out smaller local retailers.
📌 Legal Concern: Predatory pricing is illegal in many countries under antitrust laws (e.g., U.S. Sherman Act).
3. Strategic Barriers to Entry
Apart from pricing, firms use strategic barriers to deter entry:
✔ Excess Capacity:
- Incumbent firms maintain extra production capacity.
- New entrants fear a price war if they enter.
✔ Exclusive Contracts with Suppliers & Retailers:
- Firms lock suppliers into long-term contracts, making it hard for new firms to get inputs.
- Example: Coca-Cola and Pepsi securing exclusive deals with restaurants.
✔ Brand Loyalty and Heavy Advertising:
- Strong branding (Apple, Nike) creates customer loyalty, discouraging new firms.
- High advertising costs make entry expensive.
✔ Economies of Scale:
- Larger firms benefit from lower average costs, making competition difficult for small entrants.
- Example: Airbus and Boeing dominate aircraft manufacturing due to high economies of scale.
Conclusion
Entry-preventing pricing is a strategic tool used by firms to maintain dominance. Limit pricing deters entry, predatory pricing eliminates competitors, and strategic barriers create long-term entry deterrents.