Customized Products: A Competitive Analysis

Abstract

This paper investigates the competitive market for mass-customized products. Competition leads to surprising conclusions: Manufacturers customize only one of a product's two attributes, and each manufacturer chooses the same attribute. Customization of both attributes cannot persist in an equilibrium where firms first choose customization and then choose price, because effort to capture market with customization makes a rival desperate, putting downward pressure on prices. Equilibrium involves partial or no customization. In partial customization, rival firms do not differentiate their mass-customization programs: If firms customize different attributes, many more consumers are indifferent between the two firms. The elasticity of demand is increased and the resulting price war makes differentiated customization unprofitable. If firms customize the same attribute of a two-attribute product, they should concentrate on the attribute with the smaller heterogeneity in consumers' preferences. We incorporate consumers’ effort in portraying their preferences as a cost of interaction and provide public policy findings on the well-being of these consumers: When this cost is low, consumers are better off with customization than with standard goods, but firms choose too little customization. The loss in consumer surplus is sometimes captured by the firms, but for low interaction costs, firms' profit-driven behavior is economically inefficient.