In my previous post on Competitive Squeezes I described the competitive squeeze market failure that arises due to competition. At first glance, it appears as if the failure is restricted to a limited set of industries: education (job races), innovation (patent races), and financial markets (information races) are some examples. However, some reflection reveals that this market failure is far more pervasive; it affects many industries that take the form of an oligopoly or monopolistic competition.
Have you ever bought a product that had a few features too many? Ever wished it just cost less and didn’t have those features? Why does buying a computer with good physical features and a solid processor/memory also involve buying expensive state-of-the-art graphics? Or why does buying a car with a luxury interior for city-driving usually also involve buying useless engine power? Or why is half of your $200 textbook problems and notes you never read?
Each of these features differentiates the product from the competition (or does it?). However, these features may be inefficient precisely because of the competitive squeeze failure. Here, additional features may on net cost more than the benefit they produce, but are added inefficiently to capture more market share (a fixed outcome space).
An example to demonstrate (numbers are made up):
Samsung and Apple compete for the mobile market (an oligopoly). They are each considering adding cloud functionality to their mobile phone. The current cost of producing a mobile phone is $300. Cloud functionality would add an extra $50 to production costs. Assume there are three buyers on the market, who will each buy a phone, and that each company can only produce one phone model:
|Customer||Utility of Apple||Utility of Samsung||Utility of Cloud|
Adding cloud functionality to all phones is socially inefficient: it costs $50 per customer, but only has an expected return of $25 ($75/3) per customer. In the absence of some agreement, the duopoly will be cost-inefficient by adding cloud functionality; Samsung will implement it to steal customer B from Apple, and Apple will implement to prevent customer B from being stolen by Samsung (a standard prisoner’s dilemma). Thus, the cloud functionality becomes a competitive squeeze in the duopoly.
Note further that even if Apple and Samsung have an agreement to not include the cloud feature, a third competitor who would otherwise not be able to capture any of the market may come in and steal customer B from them with cloud functionality, thereby forcing them to adopt it.
In contrast, a monopolist who can produce a single phone model will not add cloud functionality. A monopolist who can produce two phone models will add cloud functionality in only one of them, but not both.
The vast majority products and services are differentiated. Thus, the vast majority of markets operate with some form of monopolistic competition or oligopoly. It follows then that competitive squeezes are a pervasive market imperfection. Logically speaking, the importance of this market failure can be quite high, and it should not be ignored when making decisions about monopoly formation.