Service Segment Competition with Strategic Customers: Size or Value, Which Matters?

Abstract

We consider a service market with two firms that provide regular and premium services respectively. Customers are delay sensitive and heterogeneous on evaluating the service level. We show that the service differentiation, together with customer heterogeneity, results in market segmentation (based on customer self-selection). We then study two competition games that differ in segmentation-marketing strategies. One is the size-based competition, and the other is the value-based competition. For both games, the Nash equilibrium always exists, and the (Pareto dominating) equilibrium is unique. Interestingly, the premium service provider's effective arrival rate can be increasing in the firm's competitor's service rate in the value-based game. Moreover, we capture the condition for the equilibrium market as either a monopoly or a duopoly and show that size-based competition helps sustain the service variety. We also show that the prices are reduced in the value-based game; the premium (regular) service provider serves more (fewer) customers in the value-based game than in the size-based game. Numerical results illustrate that the number of customers who get served, the customer surplus and social welfare are higher, while the total revenue are lower in the value-based game than in the size-based game, thus indicating that the competition is more intensive in the value-based game than in the size-based game.