Wednesday, June 23, 2010
Posted by D. Daniel Sokol
Oksana Loginova (Department of Economics, University of Missouri-Columbia) describes Competitive Effects of Mass Customization.
ABSTRACT: Earlier theoretical literature on mass customization maintains that customization reduces product differentiation and intensifies price competition. In contrast, operations management studies argue that customization serves primarily to differentiate a company from its competitors. Interactive involvement of the customer in product design creates an affective relationship with the firm, relaxing price competition. This paper provides a model that incorporates consumer involvement to explain the phenomena described in the operations management literature. Two firms on the Hotelling line compete for a continuum of consumers with heterogeneous brand preferences. An exogenously given fraction of consumers is potentially interested in customization. Consumer benefits from customization are the rewards from a special shopping experience and the value of product customization (better fitting product); these benefits are higher for consumers located closer to the customizing brand. When a consumer purchases a customized product, he incurs the waiting cost. The firms decide whether to offer customization, then engage in price competition. I show that customization increases the ``stickiness" of a consumer to the customizing firm, leading to less intense price competition. As mass customization becomes more efficient (the lead time goes down and/or the sunk costs decrease), customization by one or both firms occurs in equilibrium. I perform comparative statics analysis with respect to the fraction of consumers potentially interested in customization.