A Perfect World

I’ve been thinking about writing a fulsome post on perfect competition for a while now.

It’s as a result of a previous post here and there, new technological developments I keep seeing around and about, and as a throwback to my economics & econometrics degree (and doesn’t THAT seem a long time ago now).

The thought behind the whole thing is this;

The advances we are making are pushing us further towards ‘perfect competition’, which is increasingly making it hard for companies (especially retail ones) to generate the profits they used to.


Now, of course perfect competition is an economic theory… which it makes it highly unlikely (if not impossible) for it to occur in real life.

But essentially it’s this; if you have lots and lots of firms, each producing homogeneous goods, then no-one can make a profit.

No-one can set a price above that which other people are charging, as then people will buy the same good from a cheaper rival.

I started looking at the wikipedia entry to remind me of some of the characteristics that a perfectly competitive market can have…

  • Infinite Buyers/Infinite Sellers – Infinite consumers with the willingness and ability to buy the product at a certain price, Infinite producers with the willingness and ability to supply the product at a certain price.
  • Zero Entry/Exit Barriers – It is relatively easy to enter or exit as a business in a perfectly competitive market.
  • Perfect Information – Prices and quality of products are assumed to be known to all consumers and producers.
  • Transactions are Costless – Buyers and sellers incur no costs in making an exchange.
  • Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers.

…and realised that a lot of them are becoming a step closer.  For instance… 

Infinite buyers / Infinite sellers

Of course, ‘infinite’ is impossible.  But if you’re selling goods nowadays (computer peripherals, for example), then the number of buyers you can possibly reach has grown exponentially; whereas once you may have a shop on the main street in town, now you just need a spare bedroom and eBay and you can reach anyone in the world who’s looking to buy a cable for this or that.

 

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Which means of course there are a lot more sellers doing this.  Instead of being limited to Dixons or PC World, the buyer can choose from any number of small, bedroom retailers.

Zero Entry / Exit costs

Of course, setting up a business in your bedroom has far lower entry and exit costs than setting up a real world shop.  But it applies to big companies too, and it certainly applies to the likes of Amazon.  Because of their investment in the technology to serve other sectors, Amazon can now enter just about any goods market at minimal cost… 

 

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…if they want to start selling breadmakers, for instance, it’s just a matter of uploading the goods onto the site, and making sure the natural search & paid search works to drive traffic their way.  And if they want to stop… they can just stop.  

Perfect Information

This is something I covered in a previous post, but shall quickly reiterate here…

The rise of the ‘price comparison service’, be it for car insurance, televisions or even all the FMCG goods in your supermarket means that we all have near instant access to ‘the best deal’… and we’re getting increasingly used to finding the thing we want, and then finding out the cheapest place to buy it. 

 

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Instant comparison mobile applications like Redlaser will only fuel this sort of behaviour.

But that’s just one half of perfect information; people don’t just need access to pricing information, they also need access to quality information.  Which is where customer reviews come in; we are increasingly more likely to trust other ordinary people when it comes to ‘quality’ of goods and services than we are to trust other sources, especially ‘advertising’.

So we can quite quickly get hold of huge swathes of information on the price and quality of comparable things.

Transactions are costless

There used to be many considerations to where you got something from… how far away was it by car, for instance.  Availability of other things you wanted to do in the vicinity when there.  Parking charges. 

 

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But as people increasingly sit in front of computers to buy things, a lot of the transaction costs are disappearing. 

Indeed, the decision about whether to buy something from a site or not can be influenced by something as trivial as whether you’ve given them your details for something before, and so don’t need to fill it all out again.  Or who has the cheapest & quickest shipping.

All in all though, as the transaction costs associated with ‘travelling somewhere to buy something’ disappear, it makes the price of the actual good even more important to buyers. 

Which means as a shop, you have to sell things cheaper.

Which is a perfect world for people, of course; we buy the things we want, but at the most competitive price.

But it’s a massive issue for companies, I think; you’re always going to have to keep prices lower in the future, as not only are there more people to compete against, who’ve got less overheads than you, but there will be services out there for people to help them find the cheapest version of whatever it is they want. 

But have a look at the list of ‘perfect competition characteristics’ once again… speifically that last one…

Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers.


As all those other characteristics of perfect competition increasingly become more possible, then the best way to protect the profit you do make is to become as remarkable and differentiated as you can

The best product, design, communications, shops, customer service, aftersales, website, fan pages, competitions…

…whatever it is you do, you’ve got to use everything at your disposal to make sure that the entire experience that surrounds people when they come into contact you sets you apart from the homogenous crowd.

Otherwise you’ll be right back in there with them as the perfect world creeps ever closer…

 

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PS – There’s a fine guide to ‘remarkable’ I remember from Seth Godin & featured in the Guardian a while back; you can read the whole shebang here.

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0 Replies to “A Perfect World”

  1. 01/19/2010 at 09:52 AM January 19, 2010 at 5:52 pm

    “But essentially it’s this; if you have lots and lots of firms, each producing homogeneous goods, then no-one can make a profit.”Are you sure about this? Isn’t it just that all the variables are identical and therefore no single firm can create a competitive advantage? They must make profit otherwise it would quickly become a market failure, no competition can exist without profit because there’s no reason to compete.

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  2. 01/19/2010 at 10:49 AM January 19, 2010 at 6:49 pm

    I’m still a little rusty on me Economics, so I’ve gone to another resource, just to check stuff out (it’s here – http://bit.ly/79sUIY)…• Each firm produces only a small percentage of total market output. It therefore exercises no control over the market price. For example it cannot restrict output in the hope of forcing up the existing market price. Market supply is the sum of the outputs of each of the firms in the industry• No individual buyer has any control over the market price – there is no monopsony power. The market demand curve is the sum of each individual consumer’s demand curve – essentially buyers are in the background, exerting no influence at all on market price• Buyers and sellers must regard the market price as beyond their control• There is perfect freedom of entry and exit from the industry. Firms face no sunk costs that might impede movement in and out of the market. This important assumption ensures all firms make normal profits in the long run• Firms in the market produce homogeneous products that are perfect substitutes for each other. This leads to each firms being price takers and facing a perfectly elastic demand curve for their product• Perfect knowledge – consumers have perfect information about prices and products….which all seems entirely unlikely at any rate, and as you point out no one would want to enter that market when there’s no profit to be made, so the market would change.Where I’m coming from is that previously imperfectly competitive markets, where there was profit to be made, are being driven closer (though not actually to) perfect competition…(I oversimplified by previous synopsis I think, you’re right; I shall go back and have a tinker at that…)

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