Degree Of Product Substitutability Research Articles

The welfare effect of release timing of relative performance evaluation under quantity competition and asymmetric costs

AbstractWe examine the welfare effects of the endogenous decision and release timing of weight placed on the rival's profits under relative performance evaluation with quantity competition and asymmetric marginal costs. We find that when the advantaged firm decides and releases the weight as the leader, it always chooses a negative weight on relative performance evaluation, whereas the disadvantaged firm may choose a positive or negative weight depending on the degree of product substitution. Furthermore, we demonstrate that while all firms prefer to release weights early, this situation does not improve social welfare in several economic environments.

Exploring optimal outsourcing strategy with and without transfer payment

AbstractThis study investigates an original equipment manufacturer's (OEM's) outsourcing choice between a competing manufacturer (CP) and a non‐competing manufacturer (NP). We develop a benchmark self‐produce strategy and two outsourcing strategies to differentiate two manufacturing service providers, and examine the optimal strategy alongside an analysis of the respective incentives (e.g., a lump‐sum payment) from the two service providers. The optimal strategy depends on the difference in production efficiency, degree of product substitution, and joint effect of the transfer payments. The transfer payments contribute to a greater range of Pareto improvements, increasing the possibility of outsourcing cooperation while highlighting the role of competition intensity on the model and outsourcing cooperation partner. Effect analysis shows that in the absence of transfer payment, the optimal strategy is beneficial to social welfare. With transfer payment, the optimal strategy is changed and the firms will be more profitable, but at the expense of customers' surplus, which may result in worse social welfare. An extended analysis of mixed strategies, in which the OEM produces part of the products and outsources the rest to CP/NP, shows that while the mixed‐CP strategy can be an optimal choice, the mixed‐NP strategy will degenerate to either self‐produce or complete outsourcing to NP under certain conditions.

Coopetition Strategy Choice of Duopoly Manufacturers with Key Component Technology Transfer

This paper investigates the strategic choice of key component technology transfer between two rival manufacturers. A benchmark competition model and two coopetition models (including fixed-fee licensing coopetition and two-part tariff licensing coopetition) where the manufacturers compete for end-customer demand while simultaneously collaborating on key component technology transfer through licensing. By comparing the outcomes of the competition model and coopetition models, it is shown that: (1) The optimal strategy choice for manufacturers depends on the degree of product substitution, the interfirm power relationship as well as the production cost difference of key components. Among them, the interfirm power relationship has the most significant impact on the optimal strategy choice. (2) Under certain conditions, fixed fees and two-part tariff patent licensing coopetition can achieve Pareto improvement and reduce the retail price of products, which is beneficial to both manufacturers and consumers. (3) The production cost difference of key components significantly affects whether manufacturers can achieve Pareto improvement under two coopetition models.

Should Private Exchanges of List Price Information Be Presumed to Be Anticompetitive?

Harrington (2022) provides a novel theory that explains how a private information exchange involving gross list prices can lead to higher transaction prices. On this basis, he considers that private list price exchanges between competitors should be presumed to harm competition. The theory, which has received much attention in the context of the EU trucks cartel case, was recently referred to by the UK Competition Appeal Tribunal as a “unilateral effects” theory, given that it involves no coordination once list prices have been exchanged. Unlike conventional collusion, the theory does not rely on a monitoring and retaliation mechanism. Given its novelty and relevance for recent competition cases, we consider it useful to explore its potential limitations. We show that both the scope for and magnitude of harm are sensitive to key modelling parameters such as the number of firms, the degree of product substitutability, and the level of marginal cost—sometimes in opposite directions. We also show that there may be no scope for the anticompetitive effect when firms are capacity constrained. Finally, we discuss several additional qualitative aspects that may undermine the theory of harm: the adaptability of internal pricing processes over time, the lack of verifiability of exchanged list price information (especially when the exchange is private), and possible procompetitive or competitively neutral reasons for the conduct. We conclude that, although Harrington provides an insightful addition to the wider literature on the competitive effects of information exchanges, the effects of list price exchanges are not sufficiently unambiguous to justify a general presumption of competitive harm.

The bright side of having a strong rival under environmental certification

Third-party certification plays an important role in promoting Environmental Corporate Social Responsibility (ECSR) activities, which usually cannot be directly observed by consumers. This article studies firms’ costly abatement efforts as their ECSR, in a horizontally differentiated duopoly with asymmetric costs. We consider a Non-Governmental Organization (NGO) as the external certifier to set an ECSR standard. We show that the equilibrium certification outcome depends on the cost asymmetry between the two firms as well as the relevant market dynamics (e.g., the degree of product substitutability, consumers’ valuation for ECSR efforts). Specifically, when the cost gap between the two firms is sufficiently wide, the NGO would set a high standard to selectively target the more efficient firm. In this setting, we find that surprisingly, the more efficient firm can be better off when the abatement cost of its less efficient rival is reduced, provided that the competition is not too intense. We also examine mandatory certification operated by the government and show that a firm may prefer to have a strong rival staying in the market rather than a weak rival exiting the market. Our analysis provides a rationale for the (free) sharing of environmental technology patents among competing firms in the industry.

Management Turnover, Strategic Ambiguity and Supply Incentives

Abstract When a firm appoints a new manager, it reopens the possibility of new contractual friction with its partners. We explore strategic ambiguity as a potential for friction with a supplier. The firm’s new manager probably has fuzzy expectations about the supplier’s strategy. An optimistic manager weights favorable strategies more heavily than detrimental ones, whereas a pessimistic manager does the opposite. We show that the manager’s degree of optimism is critical: above a threshold, it can cause the supplier to change the timing of its contracting and increase its profits. We also find that this threshold degree of optimism depends on the degree of product substitution: it is more stringent with imperfect substitutes than with perfect substitutes or unrelated goods.

Export-Share Requirements vs. Production Taxes under Duopoly with Differentiated Products: A Conjecture Variational Approach

One commonly held belief, as shared by some trade theorists, suggests that trade policy is inferior to domestic industrial policy as an interventionist device. This paper compares the output level on domestic market between production taxes and export-share requirements. Two firms, one domestic and one foreign/export firm, compete in a domestic market where products are imperfect substitutes of each other, while the foreign/export firm also supplies a portion of its output to foreign market. When tax rate is positive and conjecture variation is centered around Cournot, domestic output under export-share requirements will be higher than under production taxes. The values of conjecture variation that are centered around Cournot are bounded within an open interval, with its upper and lower bound determined by four factors: tax rate and export share, domestic output of firms under the tax regime, and the degree of product substitution.

On Market Concentration and Disclosure

ABSTRACT Verrecchia (1983, 1990) introduced the proprietary cost hypothesis in which exogenous disclosure costs are a reduced-form interpretation of lost competitive advantage in product markets. We develop a micro-foundation for this disclosure cost in a Cournot game and explicitly derive the cost as a function of market structure. When the market is sufficiently competitive, this model has a reduced-form representation similar to a standard voluntary disclosure game with a partial disclosure equilibrium. Proprietary costs are increasing in the number of competitors, the degree of product substitution, overall uncertainty, and production costs. The analysis also offers new empirical predictions on the interaction between disclosure choice, managerial horizon, and entry. JEL Classifications: D82; L13; L50; M23; M4.

Competition or coopetition? Equilibrium analysis in the presence of process improvement

Coopetition is a business phenomenon that dominates many supply chains. We aim to understand why and how coopetition occurs in supply chains with the presence of process improvement in upstream component production. An original equipment manufacturer (OEM) can purchase the component from either a non-competing supplier (NS) or a competing supplier (CS) that also sells substitutable products in the end consumer market. We demonstrate that without process improvement, coopetition does not exist, because the OEM prefers sourcing from the NS, even though the CS is willing to sell the component to the OEM. Two cases are considered in which process improvement is present: supplier-initiated investment, where the suppliers conduct self-investment, and OEM-initiated investment, where the OEM invests in the supplier's process. We find that with supplier-initiated investment, the CS always prefers coopetition, but the OEM may not. When the investment is efficient, coopetition occurs as an equilibrium outcome; otherwise, competition occurs. The cause of coopetition equilibrium comes from variable process improvement incentives of the CS that derive from two driving forces: the vertical wholesale price effect and the horizontal quantity competition effect. When the degree of product substitution is low, the CS increases its investment and lowers its wholesale price, benefiting the OEM. When the degree of product substitution is high, the CS reduces its investment as well as production quantity, which also benefits the OEM. Interestingly, with OEM-initiated investment, the CS might not always choose to sell the component to the OEM, and as a result, coopetition never occurs.

Whom should I merge with? How product substitutability affects merger profitability

The paper presents a simple model of oligopoly, in which three firms produce differentiated goods. The degree of product substitutability is not uniform across goods. Merger profitability from the firms’ perspective is investigated. The model shows that the merger profitability depends on the degree of good differentiation. Contrary to what seems to emerge from different models, merger between firms that supply “more similar” product is more profitable as compared to merger between firms supplying more differentiated goods.

The Law and Economics of Non-Exclusionary Price Floors

This paper integrates two separate branches of the law and economics literature to demonstrate the two-sided risk of market exclusion by a vertically-integrated firm (VIF) with upstream and downstream market power. The ratio of downstream (retail) to upstream (wholesale) price margins is key to the analysis. A margin ratio that is “too low” can result in a vertical price squeeze. This occurs when a relatively efficient rival cannot secure the bottleneck input at a price that enables it to compete in the downstream market. A margin ratio that is “too high” creates incentives for the VIF to engage in non-price discrimination (sabotage). By raising its rivals’ costs, and in turn it downstream price, the VIF can divert demand from its rivals to itself. Displacement ratios delineate the range of safe harbor margin ratios within which neither form of market exclusion arises. The admissible range of these margin ratios is decreasing in the degree of product substitutability and reduces to a single ratio in the limit as the competing products become perfect substitutes. The challenge for policymakers is to apply these pricing constraints judiciously to prevent market exclusion in accordance with a consumer-welfare standard, while recognizing the risk that these protections can be appropriated and used strategically in the errant pursuit of a competitor-welfare standard.

Profit taxation and the optimal privatisation of state holding corporations

AbstractTo examine the optimal privatisation of a state holding corporation when the government imposes a corporate profit tax on firms, we consider a multiplant state holding corporation producing differentiated goods, competing with firms in the private sector that may be uniplant or multiplant. This set up applies to many mixed markets. We find that the optimal privatisation depends on not only the degree of product substitution and the production organisation of firms in the private sector, but also on the profit tax imposed on firms. Specifically, the optimal privatisation degree increases with the profit tax imposed on firms. There is more privatisation when state holding corporations are sold to different investors than when they are sold to a single investor, and when firms in the private sector are multiplant than when they are uniplant. Given the degree of privatisation, the private sector reduces more of its production when responding to a higher profit tax rate. Moreover, the hypothesis of profit tax neutrality holds under the optimal degree of privatisation. The result suggests that the effect of the profit tax in mixed markets can be cushioned by privatisation.

Intra-brand competition in a differentiated oligopoly

In this paper we consider a differentiated oligopoly with two product varieties that are supplied by two groups of firms. After computing the Cournot solution of the game, we study its sensitivity to different sources of competition, namely the degree of product substitutability and market composition. Market composition can change either via new firms entering one industry or via firms switching production techniques, thus modifying the intensity of intra-brand competition. After studying the welfare consequences of an intensification of competition, we identify the equilibrium market composition when firms are driven by profit considerations. All the results are expressed in terms of the degree of product substitutability and of what we define “weighted relative efficiency” (WRE), which is a parameter combining both firm characteristics and market conditions.

Coordinated Effects of Corporate Social Responsibility

This paper analyzes the coordinated effects of corporate social responsibility (CSR) in a setting where firms take into account in their objective function the consumer’s welfare in addition to their profits, produce differentiated products, and compete in quantities. We consider a symmetric case, where firms have the same level of CSR and an asymmetric case, where firms have different levels of CSR. Our results confirm that assigning a positive weight to consumer surplus makes collusion harder to sustain, as shown in the literature. However, for a sufficiently high level of CSR, collusion sustainability is actually increasing in the degree of product substitutability when firms are CSR-symmetric. When firms are CSR-asymmetric, collusion sustainability is increasing in the degree of product differentiation if products are complements. Furthermore, we show that collusion may be welfare-improving when firms adopt a socially responsible behavior, which provides an interesting background to competition authorities when analysing cartel cases.

Strategic delegation in successive oligopolies with differentiated firms

A robust result in the literature on strategic incentives is that under quantity competition firm owners induce their managers to make more aggressive quantity choices in the product market than under profit maximization. We use a standard framework of successive oligopolies with differentiated products to show that depending on the degree of product substitution, the number of upstream suppliers, and the number of downstream rivals, owners might prefer to punish their manager for additional sales, i.e. to induce them to act soft instead of tough in the product market. We also consider price competition and find that firm and supplier profits can be higher if managers choose prices rather than quantities. Consumer surplus and total welfare are always higher under price competition.

On Market Concentration and Disclosure

Verrecchia (1983, 1990) introduced the proprietary cost hypothesis in which exogenous disclosure costs are a reduced-form interpretation of lost competitive advantage in product markets. We develop a micro-foundation for this disclosure cost in a Cournot game and explicitly derive the cost as a function of market structure. When the market is sufficiently competitive, this model has a reduced-form representation similar to a standard voluntary disclosure game with a partial disclosure equilibrium. Proprietary costs are increasing in the number of competitors, the degree of product substitution, overall uncertainty and production costs. The analysis also offers new empirical predictions on the interaction between disclosure choice, managerial horizon and entry.

Strategic Delegation in Successive Oligopolies with Differentiated Firms

A robust result in the literature on strategic incentives pioneered by Fershtman and Judd (1987), Sklivas (1987), and Vickers (1985) is that under quantity competition firm owners induce their managers to make aggressive quantity choices in the product market. We revisit this result in a standard framework of successive oligopolies with differentiated products. We show that depending on the degree of product substitution, the number of upstream suppliers, and the number of downstream rivals, owners might prefer managerial incentives to be either profit-based or punish their manager for additional sales, i.e. induce them to act soft instead of tough. We further show that firm and supplier profits can be higher under price competition than under quantity competition, but that consumer surplus and total welfare are always higher under price competition.

The Interplay Between Upstream and Downstream Price Floors in Preventing Exclusionary Conduct

This paper integrates two separate branches of the law and economics literature to demonstrate the two-sided risk of market exclusion by a vertically-integrated firm (VIF) with upstream and downstream market power. The ratio of retail to wholesale price-cost margins is key. A margin ratio that is “too low” results in a vertical price squeeze, whereas one that is “too high” creates incentives for the VIF to engage in non-price discrimination. Displacement ratios delineate the range of safe harbor margin ratios within which neither form of market exclusion arises. The admissible range of these margin ratios is decreasing in the degree of product substitutability and reduces to a single ratio in the limit as the competing products become perfect substitutes. The challenge for policymakers is to apply these pricing constraints judiciously to prevent market exclusion in accordance with a consumer-welfare standard while recognizing the risk that these protections can be appropriated and used strategically in the errant pursuit of a competitor-welfare standard.

Production Coopetition Strategies for Competing Manufacturers that Produce Partially Substitutable Products

This study examines the strategic choices of two rival manufacturers between competition and coopetition. A complex relationship exists between these two firms, who manufacture substitutive products. In addition, each of these firms has an option to purchase (or sell) a key component from (or to) the other. We develop a benchmark competition model and two coopetition models in which the manufacturers compete for end‐customer demand while simultaneously collaborating on component production through wholesaling (wholesaling coopetition) or licensing (license coopetition). By comparing the equilibria of the competition model and two coopetition models, we find that the optimal strategy for coopetition is determined by not only the degree of product substitution but also the inter–firm power relationship in the negotiation of a cooperation contract (i.e., wholesale price and license fees) and the difference in production efficiency between the two manufacturers. Our research comprehensively examines how the external, relationship‐specific, and internal factors affect firms’ optimal strategy selection and suggests a broad set of decision outcomes. Our study provides important managerial implications that can be utilized as strategic guidance for firms to pursue coopetition in various business environments.

Analysis of Merger Control in a Network Products Market

Using a horizontally differentiated three‐firm model, we consider horizontal mergers and antitrust policy in a network products market, where network externalities and compatibilities between products and services are observed. In particular, we focus on the role of merger‐related network compatibility. That is, if the degree of the net degree of merger‐related network compatibility is larger than the degree of product substitutability, consumer surplus is higher than in the premerger case. In this case, the proposed merger is allowed by antitrust authorities based on a consumer welfare standard. Furthermore, relating to a merger externality on an outsider, we examine the American Online and Time Warner case.