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Dynamic pricing online should not be regulated as anti-competitive

Competition authorities are examining online retailers' use of dynamic pricing to see if it's fair to consumers – but the principle of regulating such activity is economically wrong

We could imagine, in a perfect world, that those we hire to regulate markets and the economy for us understood something about markets and the economy. Sadly we seem to be caught in one of those syllogisms – those who can, do; those who cannot, teach, or perhaps regulate.

Our problem here is the process of dynamic pricing – how the price of something might change dependent on what the seller knows about you. This is becoming more prevalent as we all shop more on the internet and – through our browsing histories and varied data collections – sellers know more about who we are.

This is such a concern to the regulators that the Competition Authority is going to have a look. There’s a concern that if the sellers know enough about us then they’ll be able to discriminate between customers and offer us different prices, which would be to the detriment of at least some of those consumers. That is, we have a potential consumer rip-off situation.

Our pity is that the competition people aren’t quite up with the idea that it’s competition itself which is the solution here – as competition always is the solution to exactly this very common problem. Business is best thought of as an anti-economics, an attempt to subvert those favoured models found in the textbooks.

Market power

Think of that theoretical model that’s been boring everyone rigid since Adam Smith – there are so many buyers and so many sellers in the market that no one has any power over prices or quantities, and everyone just has to either accept or pay the market price. It doesn’t happen perfectly very often, but it’s an ideal, and the business of being in business is to subvert that ideal.

As Warren Buffett is known to say, he likes a business with a moat, a defence around its profits. That’s exactly what he means, that there’s something there which gives it market power; some inefficiency in that perfectly competitive market.

Business is, in one squinted view, the process of trying to create those protections and inefficiencies. A brand is one such, a monopoly another – the brand having the advantage of being legal if consciously constructed, the monopoly not so much.

A key concept to grasp is that while everyone does get to pay the same price in that perfect market, those same people would be willing to pay different prices. Some people do value the same thing differently, after all. I’ll pay rather more for bacon than my kosher-keeping friend, obviously enough.

What we would pay but don’t have to is called the consumer surplus, and this is a very large part of the economy. Standard estimates of what we would pay but don’t are that it’s equal to the entire measured economy. Here’s GDP, the value of everything produced or consumed, and here’s the consumer surplus – it’s this much again.

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One obvious enough manner of trying to make a decent profit is to be in business to capture some of that surplus, to find out who would be willing to pay more and then charge them more. The standard solution to this is market segmentation, or its equal, product differentiation.

VW does this rather well. It has three or four basic cars, some different levels of trim – cloth seats to leather hide – an engine selection and some brands. Stick one engine with the hide under a Bentley badge and sell it for very much more than the same car as a Skoda. Not exactly, of course, but that is largely the basic structure of the strategy.

This way we get to charge more to those who are willing to pay more, while still keeping the custom of those who are price conscious, and in the process we’ve subverted that no market power stricture of the perfect model.

Data collection

With the internet, all that data collected as we browse does mean that more of this segmentation and differentiation can be done. Therefore, we can expect more business appropriation into profits of that consumer surplus. But we’re being ripped off, they say, and so the competition authority must investigate.

And yet those market processes still do out, for as Adam Smith pointed out and we emphasise today, economic profits do get competed away. People watch what other sellers are doing, copy them, and then that ability to collect the surplus is eroded.

Amazon, eBay, Google and the rest are looking to see where we can be charged more, but the fact they’re competing with each other for those who would pay more brings back all that competition. We end up with more fragmented markets, but each one of them is now perhaps of a size that is competitive.

Actually, it’s more likely that the process leads us closer to our perfect market. One contention is that the US market has been becoming more concentrated, with the top five firms in any one segment are gaining ever more of that market. This is true at a national level, but we don’t shop in national markets, we shop in the more local one available to us.

And those big national sellers, such as Amazon, are increasing the competition in each of those local markets at the same time as we see the national concentration. Now that you can buy groceries online, there’s nary a single grocery store town left in the country. This effect is almost certainly larger than that of attempts to nick the consumer surplus.

There really are problems that a competition authority should look at, with nearly all of them arising when there’s not enough competition. For as long as there are multiple people trying to take our money off us, we find that none of them can manage to do so excessively – simply because competition from the others doesn’t allow them to do so.

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