Limit Pricing

Limit Pricing refers to a strategy to restrict the entry of new suppliers into the market by reducing the price of the product, increasing the level of output of product, and creating such a situation that becomes unprofitable or very illogical for the new supplier to enter into the market and grab the existing market customer base.

1. Limit pricing refers to preventing new suppliers from entering the market by lowering product prices, boosting production levels, and creating circumstances that make it unprofitable for new providers to enter the market. 
2. Suppliers usually use this technique to retain existing customers and restrict new entrants by reducing the product price to increase demand.
3. Predatory pricing, on the other hand, is a tactic one supplier uses to displace another supplier already present in the market.
4. This method is not sustainable, leading to monopolistic competition and dominant suppliers in the market; therefore, it has been banned in many countries. 

Limit Pricing is a concept that might not be beneficial in the long run as the enterprise or supplier might not work on zero levels of profits for long. However, suppliers use this technique to keep their customer base or retain existing customers. Moreover, they can also restrict the entry of new suppliers by reducing the product's price. They enjoy the benefit of no new entrants and its monopolistic market benefits by again charging higher prices.

However, under this situation, the new entrants may try to enter such a market and earn hefty profits in a monopolistic market by supplying the product in short supply at much higher prices. Still, the existing supplier will manipulate and, by applying these techniques, restrict such entry and continue such monopolistic market benefits.

Let us take an example of two companies, namely Company A and Company B, in the manufacturing industry. Company A is an established company enjoying the monopolistic market. In contrast, Company B is ready to enter the market by gathering all required information and enjoys the benefit of a monopolistic market.

Now, to restrict the entry of Company B, Company A will reduce the prices of their products at such a level where the company will only recover its cost and will earn the minimum or NIL profits along with increasing the level of output as it's a well-settled economic law where supply and price of product are inversely related, i.e., lower the supply, higher will be the cost of product and vice versa, to keep away the new entrant from the market. Therefore, in the above situation, Company B will have to rethink twice whether to enter the market or not in such a situation.

• It was seen that in a monopolistic market, the supplier of goods is charging a high rate for their goods due to lack of competition in the market, so to enter into the market and enjoy such a monopolistic situation, many new entrants try to enter into the market. The existing supplier will use this technique and reduce the product's price at much lower levels and increase the output level at much higher levels. It becomes impracticable for new entrants to enter the market.
• This technique is only a way to keep out the new entrants and continue enjoying the monopolistic market.

The major differences between Limit Pricing and Predatory Pricing are as follows -

• Limit Pricing is a strategy used by the existing supplier to restrict new entrants currently out of the market. On the other hand, predatory pricing is a strategy that one supplier uses to out the other supplier existing in the market.
• Under Limit Pricing, the existing supplier will reduce the price and increase the output to restrict the entry of new suppliers. On the other hand, in predatory pricing strategy, the existing supplier will be thrown out of the market and the restriction on new entry of suppliers. In other words, it is wider in scope.
• It is very easy to prove that the supplier in the market applies the strategy of limiting price. On the other hand, it is very difficult to prove the applicability of predatory pricing strategy.
• Under limit price, the supplier will have to earn lower profits to keep out the new entrant, but on the other hand, it is not required.

• It helps the existing supplier keep the market out of the reach of other new entrants or suppliers.
• The consumer in such a situation will be benefited as the product will be available in the market at lower costs.

• As the concept of limit pricing is lowering the price of the product to be charged and increasing the output, the small suppliers will not be able to adopt such a technique as this would not be profitable to them.
• As few suppliers and new entrants are not allowed to enter the market, it gives lower revenues to the government, and the customer will have to pay more for such products.
• After a particular point in time, the consumer will understand that this is a technique being applied by the supplier to restrict the new suppliers from entering the market.

Limit Price is a technique used by many new entrants to establish their customer support or by the existing supplier to not to allow any new supplier to enter into the market; this is a methodology which is mainly used in monopolistic markets as there are no competitors and supplier could charge any amount of money against the supply of its goods. Therefore, the concept is banned and illegal nowadays in most countries.

This has been a guide to limit pricing and its definition. Here we discuss an example, evaluation of limit pricing, advantages, disadvantages, and differences from predatory pricing. You may learn more about financing from the following articles –

• Circular Economy
• Dynamic Pricing
• Price Sensitivity
• Market Penetration
• Barriers to Entry