Why do gas prices vary, or towards understanding the micro‐structure of competition

MANAGERIAL AND DECISION ECONOMICS Manage. Decis. Econ. 23: 171–186 (2002) DOI: 10.1002 /mde.1060 Why Do Gas Prices Vary, or Towards Understanding the Micro-structure of Competition Philip Bromiley*, Chris Papenhausen 1 and Patricia Borchert 2 Department of Strategic Management, University of Minnesota, 321 19th Avenue South, Minneapolis, MN 55455, USA Strategic management work on competition considers industry segments or industries for the most part. We argue that real competition occurs at much lower levels of aggregation in many industries: what we term the micro-structure of competition. Micro-structures arise from boundedly rational ﬁrms searching imperfectly for business opportunities and boundedly rational consumers searching in a behaviorally determined manner for products and services. This paper lays out the basics of the micro-structural approach to competitive analysis and presents initial propositions from that approach. Copyright # 2002 John Wiley & Sons, Ltd. INTRODUCTION This paper began from some curious observations. Gasoline, the ultimate consumer commodity, varies in price up to 20% or more within a metropolitan area. Why? Managers, including those in our executive MBA classes, see a world of opportunities. They often do not see the need to have speciﬁc and unusual capabilities or resources to enter a given business proﬁtably. Surely, their experiences cannot be all wrong? We attempt to answer these questions based on two changes from conventional analyses of com- petition. First, we take a behavioral rather than an optimizing approach to both customer and ﬁrm behavior (see Cyert and March, 1963). Thus, rather than assuming ﬁrms and consumers act in optimizing ways, we emphasize the patterns of behavior predicted by behavioral work on organi- *Correspondence to: Department of Strategic Management, University of Minnesota, 321 19th Avenue South, Minneapolis, MN 55455, USA. E-mail: pbromiley@csom.umn.edu cpapenhausen @csom.umn.edu pborchert@csom.umn.edu Copyright # 2002 John Wiley & Sons, Ltd. zations and individuals. Such work emphasizes the limitations on knowledge and information proces- sing. Second, we attempt to examine competition at a more disaggregated level than conventional analysis. While the results of this analysis have various similarities to optimizing analyses of similar problems, this paper attempts to ground the analysis explicitly in a behavioral derivation. Just as traditional economists often develop optimizing models to ﬁt patterns that others have explained already (Razin and Sadka (1995), or see, for example, the journal Public Choice), developing a given explanation consistently from a particular theoretical standpoint offers important insights. Even when two theories make some similar predictions in many cases, the differing theories often offer different explanations and understand- ings of the situation. We believe that a behavioral explanation is more realistic than the optimizing explanation, which disregards time, information, and cognitive constraints that managers actually face. It is the presence of these constraints and their interaction with the environment that largely differentiate behavioral and optimizing models.