The Hindu Business Line : Importance of competing on quality, not price

The encyclopaedic China, the knowledge-hungry Wafers and a guest were having dinner. China, playing host, asked the guest, "Will you have Coke or Pepsi?"

The guest was shocked. "Pepsi, of course," he said.

"What's the of-course to it?" asked Wafers.

"I work for Pepsi. At Pepsi anything is pardonable but not sipping Coke. A Pepsi employee seen having Coke, whatever his position in the company, is instantly given the pink slip."

As Wafers heard that with apparent disbelief, the guest added, "the same is the story at Coke. If a Coke employee is seen having Pepsi, whatever his position in the company, he is sacked pronto."

"Can competition do such crazy things to people?" Wafers wondered aloud. Even before the guest could respond, China decided to narrate a smart experiment that his professor had performed.

A bid to the bottom

Teaching Economics, the unassuming soft-spoken Professor Chatshow had told a class of students at the Indian Institute of Technology, "I am going to conduct a real auction. He or she who bids the highest should buy the product that I put up for bidding. Understood?" The class roared a "Yes" excited at the prospect of playing a game rather than be bombarded with economics mumbo jumbo.

"I have a Rs 1000 note with me. I am putting this up for auction" said Chatshow, pushing his engaging mane backwards. There was an uproar in the class. The professor was known to keep his word.

"Rs 100," screamed a backbencher. Thrilled at the prospect of making a quick buck, someone else said, "Rs 200." A jean-clad mop-haired girl yelled, "Rs 300." There was excitement all around.

Jumbo, a techie with an amazing ability at computation, punched a few numbers on his calculator and said, "Rs 425." An ashen-faced frontbencher, unsure whether the professor was up to some trick called out "600."

China himself, seated in the middle row, had put up his hand and said, "Rs 750." As the number inched closer and closer to Rs 1,000, the full import of the experiment hit the class like a tonne of brick. After a hunk had indicated Rs 999 and the professor was about to say auctioned, the class topper smilingly said, "Rs 1,000."

Prof Chatshow had then chided the class. "I was told that you were the crème de la crème of society. And you guys threw up the opportunity to win. I was willing to sell Rs 1000 for just Re 1 and you guys blew up the opportunity."

China decided to save the face of his classmates. "Yes, professor, we fell to the oldest trap of competition. I guess we should have created a cartel and bid Re 1. Then the class would have made Rs 999 and we could have split it equally amongst the 100 of us."

Chatshow smiled. "Very true; except that it would have been very difficult for all of you to come to an agreement. Even if you had agreed and one of you, just one of you, decided to break the cartel and say "Rs 2" so that he could run away with Rs 998, the price war would have caught on like a wild fire. The professor closed out, "that's why in a market where buyers are competing to buy, the price reaches its right value."

Supplier Competition

Clearly stumped by the professor's pyrotechnics, the class looked chastened. Then a front-bencher asked, "If suppliers competed with each other, wouldn't price drop?" Chatshow asked whether someone would volunteer an answer. The girl from the middle row had responded, "Professor, can I explain with an example?" And Chatshow had said, "Shoot."

"Suppose the market price of a product is Rs 500. Say, there are two suppliers, X Ltd and Y Ltd. The product quality is the same between the two companies. Consequently buyers will buy from the company which prices the product lower. Now, if one company prices it lower than the other, all customers will go to it. And if the other company prices it lower than the first, all the customers will move to the second supplier. There is no brand loyalty," she said,

"Good," said Chatshow. "So what would happen?"

A backbencher responded, "Prof, each company will keep dropping price downwards until it becomes unviable to sell. That is, the price will hit the cost of production or `the cost of production plus reasonable profit'."

A smiling Chatshow had said, "Excellent. That's why companies should never compete on price, they should compete on quality. If they compete on price, before long the product price will hit rock bottom." And since there are infinitesimal suppliers, even if one breaks the arrangement and chooses to compete on price, everyone will be forced to do so.

"But what can be done if it is a commodity? Meaning, products or services where you really can't improve quality beyond a point; say, a mobile service provider," asked China. "Simple," responded the professor. "Complicate the pricing process by offering incentives and price differentiation that become hard to compare. World over, mobile tariff is so complex that anyone who successfully constructs a model to compare the prices, would walk away with a Nobel," the professor had said, as the gong went.

The guest smiled. And so did Wafers. An instructive lesson in competition pricing indeed thought Wafers. She mentally made a point that she should somehow use this story in one of her reports in the coming month

Racy@TheHindu.co.in

http://Racycases.blogspot.com

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