Product Customization and Price Competition on the Internet

The Internet provides an unprecedented capability for sellers to learn about their customers and offer custom products at special prices. In addition, customization is more feasible today because of advances in manufacturing technologies that have improved sellers’ manufacturing flexibility. 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. We show how a monopoly seller may earn the highest profits by producing both standard and custom products and can raise prices for both types of 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 twofacility monopolist, the duopoly may underinvest in customization. Consumer surplus improves after sellers adopt customization but does not monotonically increase as customization technologies advance. When firms face a fixed entry cost and adopt customization sequentially, the first entrant always achieves an advantage and may be able to deter subsequent entry by choosing its customization scope strategically. (Mass Customization; Price Discrimination; Product Differentiation; Internet Economics)