Product Customization and Price Competition on the Internet

Abstract

The Internet provides an unprecedented capability for sellers to learn about their customers and offer custom products at special prices. Advanced manufacturing technologies have improved sellers' manufacturing flexibility. To examine how these advances affect sellers' products and pricing,we first develop a model of product customization and flexible pricing to incorporate the salient roles of the Internet and flexible manufacturing technologies in reducing the costs of designing and producing tailored consumer goods. A monopoly seller may earn the highest profits by producing both standard and custom products. Surprisingly, the monopoly can raise his prices for both standard and customized products as customization and information collection technologies improve. Simultaneous adoption of customization in a duopoly reduces the differentiation between their standard products but does not intensify price competition. Compared with a two-facility monopolist, each duopolist may under-invest in customization. Consumer surplus improves after sellers adopt customization but does not always increase as technologies advance. When firms face a fixed entry cost and adopt customization sequentially, the first entrant always achieves a profit advantage and may even deter the entry of the late entrant by choosing his customization scope strategically.

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