Limit Pricing

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Definition of Limit Pricing

Limit pricing is the practice by a competitor engaging in monopolistic behavior of setting a product or service price at a level just low enough to deter potential market entrants from competing in the market. This limit price may not be the price point at which the existing competitor earns the largest profit, but it does keep other companies out of the market.

Limit pricing must be inferred, since it is not an active monopolistic act; that is, other companies may enter the market as long as they are willing to accept the low price point or have other means of differentiating their products or services.

Advantages of Limit Pricing

The following is an advantage of the limit pricing method:

Reduced competition. A sufficiently low limit price may leave the bulk of a market to a monopolistic company.

Disadvantages of Limit Pricing

The following are disadvantages of using the limit pricing method:

Complacency. A company that successfully exercises limit pricing may become complacent and not keep its cost structure sufficiently lean to allow it to still earn a profit if a price war develops with a new market entrant. Also, if the company does not keep its products and services at a sufficiently high level, someone could sidestep the limit price with a unique product or service offering.
Illegal. Limit pricing is considered illegal in some government jurisdictions, so even giving the appearance of using limit pricing could trigger a lawsuit.

Evaluation of Limit Pricing

Limit pricing is considered illegal in some jurisdictions, and may not be effective in keeping out a determined market entrant over the long term. However, it may be useful in the short to medium term in reducing the level of competition in a market.