Why Do Sellers Race To The Bottom?

You find a great item when you are sourcing in your local store with an out of this world ROI. You start off by purchasing a few and then you start clearing the shelves. As you send these items into the warehouse, you start noticing a slow (sometimes fast) drop in the price. You start uttering statements like:

Are these people stupid!?

Why in the hell would you lower your price when it is selling at a higher price?

The other sellers on this listing must be losing money with each sale.

This is exactly why I hate repricers.

Oh great. Another race to the bottom.

I know that I have heard these around my family and in the Facebook groups. We all know that it happens, but have you actually stopped and wonder why sellers are actually racing to the bottom. I mean:

Wouldn’t everyone be better off if we just kept the prices higher?

Well yeah. That would make everyone better off (in the world of selling).

Then why in the world do sellers participate in the race to the bottom?!?!

If it is better for everyone in the selling world agreed right now to keep the prices high, why doesn’t it happen?

It’s actually quite simple (well in my head it is anyway). In order to understand why this happens, we have to take a look at a quite famous example from one of my economics classes.

prison
Ah! The prisoner’s dilemma! One of my favorite economic exercises of all time. I know that some of you reading this just threw up a little bit because I am once again bringing up economics.

Now I’ll answer the question that is on all of your minds right now.

What in the hell does this have to do with the race to bottom?!?!

Before you get all huffy and puffy, lets take a look at this example. These two fugitives just got done committing a crime and they are now both in separate interrogation rooms. Each suspect has two options: Stay silent or confess and betray.

Now by looking at the chart above, we can see that it is in the best interest of both of them to stay silent as it will result in the lowest amount of jail time for both of them.

Now doesn’t this sound a lot like a higher price? Both you and your competition would be better off if the price was kept at a higher level.

As outsiders, we can easily see what the best option is for both criminals. They should shut their mouths and not say a word.

What if I told you that the majority of the time, both of the criminals will confess? 

I’m not kidding.

Seriously.

Both of the criminals are likely to confess even though it is in their best interest to stay silent.

The study of why they will do this is called “Game Theory” and it is the study of decision making.

Don’t let the name scare you. It’s actually quite simple. Let me explain.

First we need to layout all of the scenarios and the outcomes:

  1. Both stay silent – Criminal 1 (C1) gets 1 month in the slammer and Criminal 2 (C2) gets 1 month as well – we will abbreviate this as (1, 1) since both get 1 month (the first number is for C1 and the second is for C2.
  2. C1 confesses and C2 stays silent – C1 is set free and C2 gets 12 months in the slammer. (0, 12)
  3. C2 confesses and C1 stays silent – C2 is set free and C1 gets 12 months in the slammer. (12, 0)
  4. Both C1 and C2 confess – C1 and C2 get 3 months is the slammer. (3, 3)

This clearly shows that option 1 (staying silent) is the best option.

Now let’s break it down even farther.

C1 has two options: Stay silent or confess. The outcomes are listed below:

Silent: (1, 1) or (12, 0)

Confess: (3, 3) or (0, 12)

As we can see, if C1 stays silent, his total possible jail time is 13 months (1 month + 12 months). If he confesses, his total possible jail time is 3 months (3 months + 0 months).

That exact scenario is also true for C2.

So what does that mean?

Well it means that both C1 and C2 are going to confess. It is the option with the best outcomes (in Game Theory, this is called a Nash Equilibrium).

Wait a minute. This is crazy.

Clearly it is better for them both to stay silent. Why are they being dumb and both confessing!?!?!

It all goes back to two of the driving forces of economics.

Self interest and lack of information.

Self interest is the easier one to explain. If we look at the outcomes above, we can clearly see that the best for the group is staying silent. But on the individual level, the best is the freedom that would come from confessing and having the other guy stay silent. I think we can all agree that 0 < 1.

Another thing we have to realize is that it is a game. Imagine you are criminal #1. Here is what is going through your mind.

If I stay silent and John (C2) stays silent, then we are both only going to get 1 month in the slammer. Wait. If he is going to stay silent, I don’t want to worry about my soap during shower time, so I am going to confess and be free. Oh crap. If I am doing this, odds are that jackass John is going to do the same thing. So if I stay silent, I’m going to meet Bubba and he is going to have a new boyfriend for the next year. All of the sudden 3 months looks a heck of a lot better than 12 months.

Did that make sense?

Essentially – Since I know the outcomes (and I know that the other player knows the outcomes), I can make an educated guess on which option he will choose, thus I can make my choice to make sure I get the best remaining outcome.

This brings us to the one of the biggest ideas in game theory – A Nash equilibrium.

Screen Shot 2015-12-28 at 10.42.22 AM

In plain English, this means that I pick the best choice for me based upon my assumption of what the other player is going to do.

Ok so enough with the criminals. It’s time to relate this back to the race to the bottom.

Let’s take a look at this game:

Seller 2
Hold Lower
Seller 1 Hold (10, 10) (0, 15)
Lower (15, 0) (5, 5)

This is a very common situation that happens for all of us sellers. We find an item and some other seller hops onto our listing.

Doesn’t the chart above look a lot like this one?

prison

If you actually look at it, they are almost identical. The best option for both sellers is to hold the prices at the higher level, but they will both end up lowering their prices to the Nash equilibrium.

See what I’m saying. Even though we all hate it, the race to the bottom is destined to happen.

We can’t stop it. 

Now that I have ruined your day, I want you to know that there are a number of ways that we can combat the race to the bottom and make a lot of money selling online. In my next post, I will go over the different ways we can actually manipulate the game to put the odds and outcomes in our favor.

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One thought on “Why Do Sellers Race To The Bottom?

  • January 18, 2016 at 9:36 am
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    Confusing, article just the other day talked about how dropping prices may be better than holding steady, though that article had many flaws in the reasoning. Then see this article today. Can’t have it both ways.

    Reply

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