An Empirical Investigation of Product Differentiation and Pricing Strategy: An Application to the Household Goods Motor Carrier Industry

Abstract

Analysis of interfirm rivalry has long been an important focus in microeconomic theory and, in particular, the field of industrial organization. While the theoretical literature is both rich and broad-based, its empirical counterpart has generally been far more limited in scope and is, in fact, still very much in its infancy. The seminal work of Iwata [17] provided the fundamental modeling approach for empirical estimation of the conjectural variation. According to theory, this term measures the anticipated response of competitors to a change in some strategic variable. Since in long run equilibrium, these anticipated responses in fact represent actual behavior, conjectures can be interpreted not only as ex ante strategic assumptions, but also as ex post indicators of the actual competitive process.' Thus, estimated conjectures serve as a means to econometrically capture firm interdependence. Iwata's research motivated a series of subsequent empirical analyses, for example, Gollop and Roberts [9], Appelbaum [3], and Roberts and Samuelson [25]. These studies are more ambitious and sophisticated in terms of interpretation and econometric technique. However, none have fully abandoned the restrictive assumption of product homogeneity. This assumption not only constrains the selection of an institutional context for oligopoly models, but also, by definition, disallows analysis of product differentiation as a strategic instrument. Despite recognition of this latter issue in the theoretical literature, empirical work has apparently been discouraged by the inherent complexities associated with modeling product differences. This research extends the boundary of empirical interdependent firm models to incorporate an environment of product heterogeneity. In so doing, a model is formulated in which the profit motive operates via the simultaneous determination of price and product differentiation. Ultimately, this allows testing not only for the existence of product differentiation as a competitive instrument but also for the relative import of this activity vis-a-vis strategic pricing decisions.