The Existence of Low-End Firms May Help High-End Firms

Abstract

Two models of competition between high-end and low-end products benefiting the high-end firms are presented. One is a quantity competition model, and the other is a price competition model with product differentiation. The key factor is the existence of two heterogeneous consumer groups: those who demand only high-end (name-brand) products and those who care little whether products are high or low end. We show that, under certain conditions, the profits of firms in the high-end market are larger when there are firms producing low-end products than when there are not. The existence of price-sensitive consumers who care little about product quality intensifies competition among the high-end firms. The existence of low-end firms functions as a credible threat, which induces the high-end firms not to overproduce because price-sensitive consumers buy products from the low-end firms. The result provides a new theoretical mechanism concerning the profitability and pricing of national brand firms after the entry of private labels. It has an implication for pricing and marketing strategies: Established firms should not decrease their prices after the entry of nonestablished firms.