Sampling and pricing strategy under competition

Abstract

Consumers are often uncertain about how products fit their individual preferences. In this situation, free samples can be offered to allow consumers to resolve such uncertainty before purchase. Product samples thus can build up customer goodwill for the products by reducing consumers’ risk of product fit uncertainty. However, product samples may also have negative effects, because consumers who realize poor fits after sampling trials may switch with a certain probability to competing products. With consideration of these tradeoffs, we study the sampling and pricing strategies for sellers of competing products in an oligopoly market. We formulate this problem as a Hotelling game and characterize the equilibrium solution. We first discuss the situation when competing retailers simultaneously make the decisions. We show that the intensity of product competition (i.e., the degree of product differentiation) and consumer switching behavior play important roles in determining equilibrium sampling strategy. When product competition is strong and no consumer switching behavior occurs, competing retailers always adopt symmetric sampling strategies. However, if consumer switching behavior exists and/or the product competition is relatively weak, retailers may begin to adopt asymmetric sampling strategies. Counter-intuitively, consumer switching behavior can soften price competition and thus benefit both retailers. This paper also sheds light on how the retailers’ equilibrium sampling strategy is affected by the probability of realizing a good fit with a product and the magnitude of goodwill effect. We further extend the study to the case when retailers sequentially make the decisions. Different from the simultaneous game, we find that there exists a second mover advantage in a sequential game. Thus, competing retailers may adopt asymmetric sampling strategies even if the intensity of competition is strong and consumers do not switch between retailers. In addition, both retailers may be better off in a sequential game than in a simultaneous game.