The effect of consumer heterogeneity on firm profits in conspicuous goods markets

Abstract

Consumers purchase conspicuous goods, such as luxury cars, to satisfy both social and functional needs. Heterogeneity in the emphases that consumers place on these two drivers of utility in conspicuous goods markets creates two broad groups: functionality-oriented and exclusivity-oriented consumer segments. A game-theoretic model reveals how this segmentation affects the equilibrium extent of value enhancements in functionality and exclusivity, prices and profits. We show that firms increase value enhancements in their product when functionality-oriented consumers perceive greater product differentiation. In contrast, firms reduce value enhancements in their product if exclusivity-oriented consumers perceive greater product differentiation. We also show that, in the presence of such heterogeneous consumers, lower perceived product differentiation is consistent with higher profitability. We also find conditions in which firm profits could decrease with a higher proportion of exclusivity-oriented consumers. The proposed model helps explain why conspicuous good manufacturers pursue lower within-category product differentiation (as validated empirically with an application to the automotive industry). These findings also provide prescriptions for firms' product value enhancement decisions—in equilibrium, increase in the size of the functionality-oriented consumer segment leads to reduced value enhancements in functionality and exclusivity.