Information disclosure and pricing for services with congestion: Extension vs. Encroachment

Abstract

Firms frequently introduce a new quality differentiated service to extend or encroach on the original market, such as expert consultations, airlines, and catering, thereby ameliorating the congestion effect incurred by noisy environments and waiting time. Essentially, the original and new services exhibit a two-dimensional differentiation, i.e., quality differentiation and informational differentiation, whereby consumers are informed (uninformed) of the original (new) service’s quality. Using game theory, we investigate a setting wherein the firm can strategically disclose the new service’s quality information and price services to navigate consumers’ beliefs and purchase decisions in different market structures (monopoly extension vs. duopoly encroachment). We find that the congestion effect makes the unprofitable downward extension profitable because it incentivizes the firm to provide multiple services that can segment consumers more efficiently via price discrimination for mitigating congestion costs. Also, the congestion cost enhances (ameliorates) price discrimination (price competition) under monopoly extension (duopoly encroachment). This further explains, when quality differentiation is low and the congestion cost is high, that both vertical line extension and encroachment can yield higher social welfare compared to the original market. Moreover, the low-end entrant’s profit is non-monotonic with quality differentiation, and the intermediate-disclosure strategy is optimal due to the trade-off between quality improvement and price discrimination.