Do you remember Econ 101 as a sophomore in college? Your econ prof talked about a lot of stuff that made no sense and drew a lot of graphs that seemingly created much more confusion than knowledge. She tried to explain the price elasticity of demand and you left the room scratching your head. This experience is common to many of us. But revisiting those basic principles may provide the key to understanding how the new economy is changing competition and what you need to do to survive in business, especially when it comes to marketing.
One of the topics that your microeconomics professor discussed, probably early in the semester, was market structure. Since it was fairly easy for an undergraduate to understand most of the implications of a market in which there was only one supplier, the professor might well have begun the market structure discussion by describing a monopoly. It seemed intuitive that customers’ dependence on a single supplier would accrue to the benefit of the monopolist in the form of greater profits.
The discussion then moved to an oligopolistic market structure with a few large suppliers. The rules of the market changed as competition entered the picture, but the oligopolists stilled enjoyed some level of pricing power.
Then, recognizing that students who often engaged in “irrational” purchasing behavior surrounded her, the professor explained the notion of monopolistic competition. She explained that while it made no sense to do this, some people would actually pay different prices for the same product. Consumers shouldn’t be willing to pay more for the basketball shoe with the image of some famous basketball player on it than for a shoe without that image, but they were. She went on to explain the notion of product differentiation and that marketers were responsible for developing these “perceptual monopolies” in which consumers would not accept a lower-priced, functionally equivalent substitute for a product.
Finally, she would talk about something she called “perfect competition.” In this market structure there were many small firms selling identical products for identical prices. These firms had absolutely no pricing power since any attempt to raise price would lead to zero sales (and revenue) and a lowering of prices would be met by an equal price reduction by all other firms in the market. This description led many aspiring managers to question their decision to pursue a career in business. Then the professor would make things better by indicating that this perfectly competitive market structure was real only in textbooks. While she found it to be a useful pedagogical tool, she indicated that this would not be a market structure that her students would confront in the “real world.” She concluded by examining the assumptions that must be made in order for a market to be perfectly competitive and explained that it was impossible for all of these assumptions to be met in reality.
A Funny Thing Happened on the Way to the Real World
Most managers today bemoan the rate and constancy of change. It seems as if nothing is sacred anymore. Well, maybe it’s time for us to reexamine some of the assumptions that underlie a perfectly competitive market structure and see if it is still a “textbook only” view of the world. If it is, in fact, becoming reality, the implications for managers are enormous.
One of the assumptions of a perfectly competitive market is that there are no transaction costs incurred when buying in one market and selling in another; that is, prices are identical. It has long been possible to engage in discriminatory pricing (simply defined as selling the same product for different prices in different markets), especially when national boundaries were being crossed. Moving products great distances in international trade assured that there would be substantial transaction costs involved. This decreased the likelihood of arbitrage (buying in one market and selling in another) across the different markets. However, with the dramatic improvements in logistics and materials handling that have occurred in recent years, the transportation related costs of products have fallen dramatically. It is not uncommon for the transportation costs from Chicago to Los Angeles to be greater than those from Los Angeles to Beijing. Another example is the dramatic decreases in transaction costs in financial markets. These are clear indications of the trend toward continually decreasing total transaction costs in many markets. The bottom line is that we are steadily moving in the direction of meeting the transaction costs assumption for perfectly competitive markets.
There must also be no barriers to trade for perfectly competitive markets to develop. With the advent of regional economic blocks, such as the European Union and NAFTA, both tariff and non-tariff barriers are being rapidly reduced or eliminated in many parts of the world. The inclusion of a greater number of nations in the World Trade Organization is also providing momentum for the further reduction or elimination of trade barriers.
Recall from above that another assumption underlying the perfectly competitive markets model is that identical products are being sold for identical prices. The marketer’s salvation in terms of avoiding the price-based competition of a perfectly competitive market has always been product differentiation. A marketing manager’s ability to avoid having the company’s products perceived of as being homogenous with substitute products has historically been the root of the marketer’s value to the organization. In a perfectly competitive market setting, there is no need for marketers. Since products in this perfectly competitive market are perceived as being identical, the only component of the marketing mix that would impact a customer’s choice of products would be price. Even price cannot be used competitively in a perfectly competitive market since any price reduction would result in an immediate matching of the reduction by competitors and any attempt to increase price would result in zero sales since customers could get the identical product at a lower price elsewhere.
As indicated above, the marketer’s role has been to attempt to achieve differentiation of his product from competing products. This is where the rub comes in. Differentiating products has become more difficult in today’s world of global competition. Let’s examine a final assumption of the perfectly competitive market structure that is being impacted in this tumultuous environment before attempting to more fully determine what the implications of all this might be for managers.
In order for a perfectly competitive market structure to exist, the participants in the market must have access to perfect (or complete) information. The buyers in a market must know exactly what is for sale, where and at what price. This is perhaps the assumption that is witnessing the greatest impact in today’s environment. Whether we refer to this environment as the “Information Age” or the “information revolution,” the fact is that we have more information available more quickly and less expensively than at any point in history. This trend appears set to accelerate in the future. For example, in the U.S. market it is now uncommon for a consumer to enter negotiations to purchase an automobile without accurate information as to the product’s cost, performance, etc. This is a source of great frustration for automobile dealers as it has resulted in a reduction of their profit margins. Another example of the impact of information is found when looking at individual investors in equities markets. Such investors/purchasers often have access to information that only brokerage firms would have had access to only a few years ago. This dramatically impacts buying behavior.
The End of Marketing as we Know It?
Simply stated, a marketer’s primary job in developed economies has always been to create a monopoly. Okay, so in the U.S. and some other countries it’s illegal to have a real monopoly. However, if the marketer’s job is accomplished, a perceptual monopoly can exist and is perfectly legal. This is the whole idea behind the monopolistically competitive market structure. There are multiple suppliers for the product, but in the customers’ minds there are no acceptable substitutes. (If you’ve ever taken a child to buy a pair of basketball shoes, you know what happens when he or she sees the pair with the image of the guy flying through the air; there’s no acceptable substitute!)
If the trends toward more complete information, reduced transaction costs, elimination of barriers to trade and increased levels of education (since people need to know how to use the information) continue, does this mean that marketing as we know it will cease to exist? After all, if managers are reduced to competing purely on the basis of price, what is there for a marketer to do? If customers are simply too well informed or too smart to have their perceptions shaped by savvy marketers, are we at the end of an era? Is it possible that the well-educated twelve year old will soon say, “Dad, I want the $15 shoe instead of the one with the guy flying through the air because it costs a lot less and is the same product?” Well, that seems unlikely, but it may be that the forty-year old Dad will make such an assessment about many of the products that he might purchase.
How to Stay Out of the “Home for Old Marketers”
If you’re a marketer, what can you do to survive after the impact of the big asteroid (aka, the “Information Age”)? While the buzzwords “relationship marketing” may have been overused, or even abused, their impact could be quite significant. Even if we do live in an era of decreasing transaction costs and increasing availability of information, the “high touch” component of a product (building a relationship with the customer) might still afford us an opportunity to differentiate our product offerings.
Every person in the world is unique. If we provide our customers with an incentive to share information about themselves that allows us to know how they are unique (and, if we don’t violate their trust by selling/sharing this information), we will put ourselves in a position to customize (differentiate) our product offerings to their individual needs/tastes. For example, when a bank agrees to “help” a consumer manager his finances by offering services such as bill paying, the customer is required to share/input information with the bank. While a competitor can offer to do the same thing, perhaps at a lower price, the customer will not be excited about having to input all of this information a second time. If the bank also consistently meets the needs of the customer, it is even less likely that the customer will defect. The bank has built and strengthened a relationship with the customer that is not easily broken. Having a trust-based relationship with customers makes them comfortable in sharing with us the ways in which we can serve their needs.
Will it be easy to thrive (or even survive) in this environment? No. But, it is possible. And, if done well, this approach to our customers will allow us to maintain strong profit margins. Developing relationships with customers is time consuming and resource intensive. Yes, marketers can (and some will) survive these radical changes in the environment. They will just have to work harder and smarter.