The curious case of competition and quality

Why should firms compete? The belief is that through competition society benefits with lower prices, better quality and services, and more innovation. Indeed, anyone who frequents restaurants or hotels protected from competition can recount the inferior meal, poor service, and high price. By contrast, in a competitive environment we expect more quality, for less.

Often, competitive markets develop products ranging in price and quality. Well-informed consumers evaluate the goods and make their own trade-off between price and quality. We may opt to purchase our baguette at our local organic baker, Marks and Spencer, or Asda.

Competition authorities agree that quality can be as, if not more, important than price competition. Cartels that degrade quality (but not price) are just as culpable, under the competition laws, as cartels that fix price. Indeed, quality competition has increased in importance over the past twenty years with the growth of free online goods and services.

So how do competition authorities assess how a merger or restraint will impact quality? In some industries such as health care, competition authorities rely on well-accepted measurements of quality. But many industries do not lend themselves to well-accepted quality metrics that can be analysed quantitatively and objectively. In such cases, the competition authorities rely on two simple assumptions: First, more competition will generally increase quality for a given price (or reduce price for a given level of quality). Second, when prices and quality vary, consumers will weigh the offerings using an internal price-quality metric. Price adjusts for quality, and consumers rely on the heuristic “you get what you pay for.”

Often, these two simple rules work well. But, at times, they don’t. Sometimes, the increase in competition does not increase quality where one expects it should. Further, in some unique cases, more competition actually reduces quality and may give rise to significant health and safety issues.

So what is going on here? Why doesn’t the pressure of competition always increase quality? Two underlying factors characterise these instances: first, it is prohibitively expensive or difficult to convey to consumers the inherent quality differences in the product offerings; second, consumers’ ability to accurately assess quality differences is limited.

To illustrate, let us consider cases where an increase in competitive pressure can reduce quality. A producer may choose unilaterally to degrade quality, when this represents the easiest (or only) path to successfully absorb the pressures of fierce competition. Quality erosion may lead to a competitive race to the bottom. Suppose several smaller suppliers are dealing with powerful retailers. One supplier decides to secretly lower its product’s quality slightly in order to meet the retailers’ pressures to lower price. Other sellers must now also degrade their products’ quality in order to remain competitive. Absent consumer awareness, quality control or effective regulation, consumers are increasingly buying poorer quality goods. This race-to-the-bottom is not limited to product quality. Sellers may further externalise costs by using child labor or polluting the environment.

Take for example the horsemeat scandal which dominated the media in Europe in 2013. Following an investigation by the Irish Food Standards Agency, many prepared meals across the EU were found to contain horse meat despite the meat being advertised as 100% beef. In another, unrelated instance, McDonald’s sales in Asia dropped after the discovery that its supplier was accused of repackaging old meat as new. In Sweden, a conspiracy to repackage out-of-date meat was exposed and led to a criminal investigation into four stores in the Swedish ICA supermarket chain. In another instance products carrying the budget private label “Euro Shopper” were found to contain water as the main ingredient, leading to retailers terminating their supply agreements.  A similar practice of adding water to fish products was exposed in Germany, leading to a removal of Edka private label King Prawns from shelves. Importantly, these markets exhibit fierce competition which normally would lead to higher quality at lower prices. Yet, here, the competitive downward pressure on price led to suppliers’ attempts to secretly reduce quality and costs.

Interestingly, quality erosion may also occur in heavily-regulated industries, such as air travel. The proliferation of budget airlines has increased the pressure on many airlines to provide services at lower costs. Some of the price reductions are accompanied with transparent changes to quality of service. Others, however, may involve disguised variants. Indeed, intense competition may induce airlines to exploit consumers’ behavioural biases, involving less salient factors such as air-quality in airplanes, quality of frequent flyer programmes and other ancillary services.

The competitive pressure may have also affected fuel supply levels and air delays. According to the regulatory framework, airlines should allow enough fuel to reach their destination, with an additional 30 minutes flying and a final approach before landing. Usually, low fuel incidents take place in the event of bad weather, where planes will likely spend more time in the air than originally planned. Reportedly, pilots can be under pressure from the airlines’ needs to minimise costs and carry the lowest fuel intake permitted by the regulations. As one pilot reported: “I’m constantly under pressure to carry less fuel than I’m comfortable with … Sometimes if you carry just enough fuel and you hit thunderstorms or delays, then suddenly you’re running out of gas and you have to go to an alternate airport.” As passengers are often unaware of this quality dimension, it remains undetected.

So, everyone agrees that quality is a fundamental aspect of competition. Often more competition will generally increase quality. But this isn’t always the case. First, consumers may be unable to accurately assess quality differences. This may be attributable to external factors (such as deceptive claims) or dispositional factors (such as consumer biases or imperfect willpower). Second, imperfect information flows make it difficult or costly to convey to consumers the products’ or services’ inherent quality differences. Companies recognise that neither they nor their competitors can easily or inexpensively convey to consumers the inherent quality differences in their and their competitors’ product offerings. They may be motivated to exploit this weakness when likelihood of detection is low. Ironically, in these extreme cases, the greater the competitive pressure, the greater the risk they may take in degrading quality. Consumers, in such instances, do not benefit from the competitive process. While paying less for a product or service they receive much less. In such cases, competition can turn into a race to bottom, where the environment is despoiled, the planes lack sufficient fuel, our burgers feature something other than beef, and our online search engines provide less than objective search results, despite competition being one click away.

So, competition authorities must exercise greater caution in markets characterised by the two conditions identified. If they don’t, and simply assume that more competition will solve the problem, they will fail to appreciate that consumers won’t always get what they paid for, even when competition is fierce.

Featured image credit: bland new architecture in bognor regis high street by shrinkin’violet. CC BY 2.0 via Flickr.