Here’s an interesting market experiment that you can try without leaving your desk. Go to www.pricegrabber.com, choose a merchandise category, and then select a product that has more than a half-dozen or so different sellers. Sort the list by price, and compare the highest price to the lowest. Having just performed this for the HP Laser Jet 1022n laser printer, I see that I have the option to pay as much as $290.00 or as little as $115.00, plus a range of prices in between. That’s a lot of variance for the exact same product. The highest price is almost three times as high as the lowest. Yet all sales have not been captured by the lowest-price seller, nor has the most expensive retailer (which happens to be HP itself) gone out of business. Intuitively, you may already be rationalizing this phenomenon to yourself. People are willing to pay for things like the seller’s brand strength, return policy, warranty, service packages, availability, and so on, which is why different prices are charged. I didn’t bat an eyelash when I saw the price range on the screen, even though it seems to contradict the premise of market-clearing prices in perfectly competitive, transparent markets. We understand the reasons for these differences, but there is a deeper insight to be gleaned from this apparent oddity.
Let’s say hypothetically that this printer has 10 different attributes like the ones mentioned above on which every buyer places a value, even it happens to be zero. There is a segment of the printer-buying population that wants all 10 attributes, including the HP brand name of the seller, and that segment is willing to pay a higher price. No other seller can satisfy all 10 attributes, giving HP a monopoly on that attribute set. But as a seller, HP operates within constraints since other sellers offer the same exact printer at a lower price in return for providing fewer attributes. Thus, HP cannot set its prices as a pure monopolist, because an excessively high price will drive too much of the market to the next lowest price tier. HP’s competitive position is what I call a micro-monopoly (or “Micropoly” if you prefer the conflation, as I do). The explanation for this price dispersion is that every seller of this printer satisfies a unique mix of attributes demanded by a particular segment of the market. For that segment, the seller has a limited amount of micro-monopoly pricing power.
When viewed from this angle, it becomes easy to see why it makes more sense to set prices based on what your customers value rather than what your competitors charge. The reason is that one firm may compete only tangentially with another firm that sells the same products. The obvious question then is what happens when two firms fulfill the same exact mix of attributes. At this point, firms would then compete on price, but I think this logical extension can be somewhat misleading. In the real world, no two firms ever truly occupy the same attribute space. There will always be at least some differences in the total experience and feel that the customer gets from making the purchase, and thus the potential for price differentiation exists. Multiple optimum prices for the same product can exist in the marketplace. A profit maximizing firm’s objective should not be to race to the bottom in a low price battle with competitors, but rather to understand very clearly what its price ceiling is.