Price Competition Is A Dying Phenomenon
Consumers Need A New Tool To Keep Prices At A Commercially Reasonable Level
By David Grace (Amazon Page — David Grace Website)
The Free Market & A Price-Competitive Market Are Two Different Things
Conservatives are always babbling about a “free market,” but what they really mean is a price-competitive market. They think that everything offered for sale in a free market is automatically subject to price competition and that price competition will always provide better goods at a lower price.
All of that is false.
These conservatives are like doctors using two-hundred-year-old ideas about leaches and therapeutic bleeding to treat a patient today.
The problem with conservatives’ misunderstanding of price competition is that their understanding of economics is based on how prices for bread and candles were observed by Adam Smith back in 1776, none of which has much relevance to how the market sets prices for many important products today.
While there is a public market for goods and services, the prices of those goods and services are increasingly not subject to substantial price competition.
There is little to no price competition today for generic drugs, rental property, diapers, farm equipment, lumber . . . . The list goes on and on.
The continued existence of a colony of flourishing plants requires specific soil, temperature, rainfall, insect and climate conditions. Materially change any of those characteristics and the plants will wither and die.
It’s the same for price competition.
A price-competitive market is not a universal, automatic condition. It only exists under limited economic conditions, many of which have changed dramatically over the last 80 years.
Change the available marketing tools, distribution channels, market concentration, data available to sellers, costs and time for market entry, intellectual property barriers, cost and time constraints to increase production, or raw material restraints and price competition for that category of product will wither and die.
New Marketing Tools Beyond Price
In the “old days” the only material marketing strategy was word of mouth and newspaper ads mostly saying, “Mine is cheaper” or “Mine is better.”
Today sellers can market with:
- Nationwide brand loyalty
- Television and streaming video
- Celebrity/Influencer endorsements
- media tie-ins
- Electronic discounts
- Contests
- Subscriptions
- Niche/demographic targeting
- Controlled distribution channels
- Media tie-ins
and more. Today sellers can maintain a high or higher price than market price competition would have forced them to charge if they were selling their product back in the days when a lower price was their principal competitive tool.
Market Concentration
If there are ten or twenty product sellers of about an equal size, price may be a major sales consideration.
But, if three or four sellers who collectively have greater than a 60% market share for a vital product, then those sellers will automatically switch from competitive pricing to follow-the-leader pricing because they know that there are no other sellers who will be able to fulfill a majority of their customers’ needs at a lower cost, that their customers are locked-in.
Limitations On Supply
If the supply of the product, e.g. bread or candles, can be greatly increased almost overnight, if new sellers can quickly enter an over-priced market, then price competition can arise and will potentially drive prices down.
When the additionally available supply of a vital product is less than half of the market share of the largest seller, that seller has little to lose by increasing its price because most of its customers will have nowhere else to go.
Moreover, other sellers know that they will make more money by increasing their price to match the major seller’s higher price than they will make by offering a lower price and servicing some of the customers fleeing the higher priced brand.
When supply is constrained and the market share is concentrated, sellers servicing the overwhelming majority of the consumers in the market will not lower prices to compete with their rival but instead they will increase their prices to follow their rival under a follow-the-leader pricing model.
Limited Distribution Channels
Most grocery items are purchased through a small number of sellers. If you want to sell cookies, ketchup, etc. you have to convince Walmart (25%), Kroger (15%), Safeway (8%) etc. to put your product on their shelves.
If you sell your new “just as good as Heinz” ketchup to a grocery chain for $2 the average retail price will be about $2.80. If Heinz sells its ketchup to the chain for $3.50 the retail price will be $4.90. The store’s gross profit on the new, cheaper ketchup is only $.80 versus a $1.40 gross profit on the Heinz ketchup.
It is in the store’s best interest not to stock your cheaper ketchup because it can make sixty cents more per unit by limiting the shelf space to Heinz and its house brand. Instead of selling your cheaper brand, it will commission a private label ketchup that it can buy for $1.75/bottle and sell for $4/bottle at a gross profit of $2.25/unit.
Without those distribution channels, your “good as Heinz” ketchup is DOA.
In taste tests, Hunt’s ketchup is rated to be almost identical to Heinz and is priced at about 60% cheaper than Heinz, but it is almost impossible to find Hunts in many major supermarket chain stores. Safeway makes much more gross profit by selling Heinz for a high price and offering its house Signature brand ketchup at a lower price.
Hydrox was the first company to make a chocolate-cream-filled cookie. Then Oreo locked up the distribution channels and Hydrox cookies disappeared.
High Barriers To Market Entry
Producing some bread or candlesticks for the neighborhood market is pretty easy. Producing enough lumber, gasoline, insulin, meat, diapers, etc. to satisfy 10% or more of the entire national market is extraordinarily difficult and expensive. The cost to build factories to do that would be at least five or ten billion dollars.
Moreover, you would need a huge network of distribution channels what would agree to deliver your product. And you would have to spend at least a quarter of a billion dollars on the initial marketing expenses.
No one with billions of dollars to invest would spend that money just to sell a cheaper product in competition with major, existing sellers.
High entry costs, long lead times, existing brand loyalty, intellectual property barriers and distribution barriers deter new entrants from entering a concentrated, existing market, and there is no realistic profit large enough to justify attempting to overcome those barriers with the sole purpose of selling a product at a lower price.
Large consumer-product companies are not altruists.
Information Technology Empowering Follow-The-Leader Pricing
For the first time in history, thousands of independent sellers have instant access to each other’s pricing practices. Software is now used by tens of thousands of landlords to discover the highest rent being charged for similar properties in their locality.
This information allows these independent landlords to increase their prices to match the highest prices charged by other sellers. For the first time, information technology is enabling follow-the-leader pricing.
If I can rent out all 100,000 square feet of my property at $3/sq. ft and only 80,000 square feet at $4/sq ft, I will make $20,000/month more money by raising my rent to match another landlord’s $4/sq ft price and living with the 20% vacancy factor, and so will other landlords.
If the available supply of an important product is limited then there is no reason to price compete because sellers know that they will make more profit by raising prices and selling fewer units than by lowering prices and selling more units.
The False Assumption That Sellers Will Lower Prices To Increase Sales
The increased concentration in distribution channels and concentration of product sellers coupled with the greatly increased time and cost barriers to market entry or to increase supply have critically wounded price competition.
Price competition is like a native plant that has run into an invasive species that is choking it to death.
Consumers Need A New Tool To Resurrect Price Competition
Consumers need a new strategy, a new tool, that will force sellers to offer goods and services at a competitive price. A competitive price is one that is equal to Cost + Overhead + a Profit of Less Than 25% of C + O.
My suggestion is to kill the weed of excess pricing at its root. Remove the incentive to increase prices by taking the profit out of charging a higher price. Remove the sellers’ ability to increase profits by adding fees, reducing quantity or quality or lowering wages.
You do that by making sellers function in an economic environment where the only way they can increase after-tax profits is by selling more units at a lower price rather than selling fewer units at a higher price.
An Excess Profits Tax
You do that by charging an excess profits tax of 100% of the seller’s profits that exceed 25% of the total of the seller’s Cost + Overhead to produce that product. You eliminate the incentive for higher prices by eliminating the net, after-tax profit from charging higher prices.
Take away the economic incentive to do a thing and people will stop doing that thing.
— David Grace (Amazon Page — David Grace Website)
