Horizontal Product Differentiation Research Articles

Personalized pricing versus showrooming: competition between online and offline retailers

AbstractThis study examines how personalized pricing affects customers’ showrooming behavior in the duopoly competition with horizontal product differentiation between traditional and online retailers. For the available personalized pricing strategies, we obtained the optimal decisions for both retailers in the scenarios with and without showrooming. Our results indicate that adopting personalized pricing under particular conditions enables each retailer to be more profitable, even in the presence of showrooming purchases. This finding explains why an increasing number of online and offline retailers have implemented personalized pricing based on technical means and consumer purchase records. It is also demonstrated that personalized pricing can counter showrooming behavior of consumers amidst the competition between both retailers, which provides a novel theoretical basis for dealing with cross‐channel shopping in multichannel retail competition. We further clarify how retailers can avoid being trapped in a prisoner's dilemma when both sides have access to personalized pricing. Also, the adoption of personalized pricing can improve consumer surplus and social welfare.

Postsearch uncertainty, product heterogeneity, and price divergence

AbstractWe develop a consumer search model in which consumers may remain uncertain about product quality even after inspecting the product. We first consider the postsearch uncertainty regarding vertical quality, and characterize the separating equilibrium in which firms with different quality levels charge different prices. If quality information is not sufficiently transparent after the search, then prices between the low‐ and the high‐quality products can either diverge or converge as the search cost decreases, depending on the degrees of horizontal and vertical product differentiation. We further extend the model to include the postsearch uncertainty about the horizontal match value and to endogenize the firm's quality choice.

How does firms’ cost structure affect their quality–price mix? An experimental analysis

Experimental literature on product differentiation is scarce and mostly focused on horizontal product differentiation. This paper focuses on vertical product differentiation considering a quality-then-pricing duopoly game and exploring how firms’ cost structure affects firms’ decisions and market structure. Two scenarios are considered, differing in the way quality affects production costs: in the first, quality is costless, while, in the second, marginal production costs increase with quality. We explore the impacts on market coverage, qualities, product differentiation, prices, and intensity of competition (assessed by price-cost margins). Our experimental results confirm the (theoretically proved) need to endogenize the market structure, as a duopoly with full coverage emerges when quality is costless, but a duopoly with partial coverage emerges when quality is costly. We also find that quality differentiation is lower in the lab than what is theoretically predicted, and lower in the costless quality treatment. The intensity of competition is higher when quality is costly, as price-cost margins are lower in this case.

Price Competition with Differentiated Products on a Two-Dimensional Plane: The Impact of Partial Cartel on Firms’ Profits and Behavior

A numerical procedure capable of obtaining the equilibrium states of oligopoly markets under several assumptions is presented. Horizontal and vertical product differentiation were included by taking into account Euclidean distance in a two-dimensional space and quality characteristics of the product. Different quality preferences of consumers were included in the model. Firms implement two strategies in the market: profit maximization and market share maximization. Numerical discretization of a two-dimensional area was performed for computing the equilibrium prices which allows one to consider any market area and any location of the firms. Four scenarios of oligopoly markets were developed by combining both strategies from one side and competitive behavior and a partial cartel agreement from another side. The main differences between the scenarios are outlined. Profits, market shares and equilibrium prices are presented and compared. The influence of collusion, the existence of participants with a market share maximization strategy and consumer preferences on the firm’s profits and equilibrium prices were examined. Cases whereby firms prefer to leave the cartel were investigated. Best locations for the setting of a new store for profit maximization are shown and discussed.

Horizontal product differentiation in Varian’s model of sales

We consider the explicit introduction of firms’ choice of location into Varian’s model of sales. In our model, firms compete for both uninformed and informed consumers in a two-stage spatial competition model in which firms choose price and location. We obtain a result where both prices and locations are randomized in the subgame perfect equilibrium. The difference between each firm’s choice of location in the subgame perfect equilibrium is neither purely maximized at both ends of a line nor purely minimized at the center. Also, the expected profits in a subgame perfect equilibrium are equal to the maximum profit from an uninformed market in the absence of informed consumers. Thus, even when product differentiation is explicitly introduced into a Varian-type model, Varian’s implication can be retained; the opportunity for profit in an informed market is lost due to competition.

The effects of personal information on competition: Consumer privacy and partial price discrimination

This article studies the effects of consumer information on the intensity of competition. In a two dimensional duopoly model of horizontal product differentiation, firms use consumer information to price discriminate. I contrast a full privacy and a no privacy benchmark with intermediate regimes in which the firms can profile consumers only partially. I show that with partial privacy firms are always better-off with price discrimination: the relationship between information and profits is hump-shaped. In particular, competing firms prefer to target consumers with partial but asymmetric information about preferences. Instead, consumers prefer either no or full privacy in aggregate, but the effects of information on individual surplus are ambiguous: there are always winners and losers. Finally, I study the information acquisition incentives of the firms when there is an external data seller. When this upstream data broker holds partially informative data, an exclusive allocation arises. Instead, when data is fully informative, each competitor acquires consumer data but on a different dimension. These findings are relevant for the strategic decisions of firms active in digital markets and contribute to the policy debate surrounding privacy, exclusive access to data and competition.

The Connection between Imported Inputs and Exports: The Importance of Strategic Interdependence

Ignoring strategic interactions among final goods producers, the extant theoretical literature shows that lower costs of imported inputs increase the exports of the final goods using those inputs. Hence, it does not explain the empirically relevant positive relationship between the costs of imported inputs and the export of the final goods. We use a simple Cournot duopoly (i.e., duopoly quantity competition) with homogeneous products to show that if the exporters differ in input coefficients, lower costs of imported inputs may increase or decrease the exports of the final goods. Thus, we argue that strategic interdependence among the exporters can be an important factor for the positive relationship between lower costs of imported inputs and the export of the final goods. We further show that a lower cost of imported inputs may reduce the consumer surplus, total profits of the exporters, and world welfare. We also show the implications of a Bertrand duopoly (i.e., duopoly price competition) with horizontal product differentiation for our analysis.

Sourcing strategies of manufacturers with customer returns and product design efforts

AbstractWe develop game‐theoretic models to study the sourcing strategies of the two competing manufacturers who face customer returns due to product design mismatch. The manufacturers have opportunities to reduce the likelihood of customer returns by putting efforts into improving product design. Each manufacturer has the option to outsource product design and production to an upstream supplier or keep product design and production internally. We show that the sourcing decisions of the two manufacturers depend on the level of relative return from design investment (determined by the cost of design efforts, degree of horizontal product differentiation, and expected costs related to returns). We identify the sourcing strategy equilibrium and show that the higher cost of design effort and/or the higher degree of horizontal product differentiation expand, while the higher costs related to returns shrink, the range in which symmetric outsourcing is an equilibrium. Furthermore, as compared to symmetric insourcing, symmetric outsourcing not only softens the price competition but may also increase design effort levels, and thus both manufacturers are better off from outsourcing. However, symmetric outsourcing may hurt both consumer surplus and social welfare.

The R&D Investment Decision Game with Product Differentiation

Abstract This article extends the cost-reducing R&D model with spillovers by d’Aspremont and Jacquemin (1988. “Cooperative and Noncooperative R&D in Duopoly with Spillovers.” The American Economic Review 78: 1133–7, 1990. “Cooperative and Noncooperative R&D in Duopoly with Spillovers: Erratum.” The American Economic Review 80: 641–2) to allow quantity-setting firms (Cournot rivalry) to play the non-cooperative R&D investment decision game with horizontal product differentiation. Unlike Bacchiega, Lambertini, and Mantovani (2010. “R&D-hindering Collusion.” The B.E. Journal of Economic Analysis & Policy 10 (Topics): 66), who identify a parametric region (defined by the extent of technological spillovers and the efficiency of R&D activity), in which the game is a prisoner’s dilemma (self-interest and mutual benefit of cost-reducing innovation conflict), this work shows that product differentiation changes the game into a deadlock (self-interest and mutual benefit do not conflict), regardless of the parameter scale (i.e. also in the absence of spill-over effects). Then investing in R&D challenges the improvement of interventions aimed at favouring product differentiation. This is because social welfare when firms invest in cost-reducing R&D is greater than when firms do not invest in R&D. Alternatively, R&D subsidies can be used as a social welfare maximising tool also in the absence of R&D spillovers. These results also hold for price-setting firms (Bertrand rivalry).

Foreign market entry, upstream market power, and endogenous mode of downstream competition

AbstractIn a differentiated duopoly model of trade and FDI featuring both horizontal and vertical product differentiation, we examine whether globalization and trade policy measures can generate welfare gains by leading firms to change their mode of competition. We show that when a high‐quality foreign variety is manufactured under large frictions due to upstream monopoly power, a foreign firm can become a Bertrand competitor against a Cournot local rival in equilibrium, especially when the relative product quality of the foreign variety is sufficiently high and trade costs are sufficiently low (implying higher input price distortions due to double marginalization). Our results suggest that such strategic asymmetry is welfare improving and that the availability of FDI as an alternative to trade can make welfare‐enhancing strategic asymmetry even more likely, especially when both input trade costs and fixed investment costs are sufficiently low and trade costs in final goods are sufficiently large.

On Jain’s digital piracy model: horizontal vs vertical product differentiation

We study how private intellectual property rights protection affects equilibrium prices in a duopoly competition between firms that offer a product variety of distinct qualities (vertical product differentiation) in a setup that is closely related to that put forward by Jain where firms offer the same qualities in equilibrium (horizontal product differentiation). Consumers may make a choice to buy a legal version, use an illegal copy (if they want to and can), or not use a product at all. Using an illegal version violates intellectual property rights protection and is thus punishable when discovered. Thus, both private and public (copyright) intellectual property rights protection are available on scene.

Limited perception and price discrimination in a model of horizontal product differentiation

We analyze the implications of consumers' limited perception in a model of horizontal product differentiation. Consumers with limited perception do not necessarily notice all goods in the market. Limited perception thus offers a market segmentation into consumers who notice only one good and consumers who notice all goods. Our objective is to analyze whether less perception is harmful to consumers when firms use this segmentation to price discriminate. We show that product differentiation under limited perception is less extreme than under full perception. Consequently, despite firms' ability to price discriminate, average prices may be lower under limited than under full perception. In addition, we show that consumer surplus and welfare are not maximized under full perception but increase for some degree of limited perception.

On a Bertrand Duopoly Game With Heterogeneous Expectations and Emissions Costs

This study was based on the dynamics of a nonlinear Bertrand-type duopoly game with differentiated goods, linear demand and a cost function that included emissions costs. This duopoly game was modeled with a system of two difference equations. Existence and stability of equilibria of this system were studied. It was shown that the model gave more complex chaotic and unpredictable trajectories as a consequence of changes in the speed of adjustment parameter and horizontal product differentiation parameter. Numerical simulations showed that a higher value of the speed of adjustment and a higher or lower (negative) value of product differentiation (weaker or fiercer competition) can destabilize the economy. The chaotic features were justified numerically via computing Lyapunov numbers and sensitive dependence on initial conditions. Also, it was shown that in this case of a duopoly game, there were stable trajectories, and a higher (lower) degree of product differentiation did not tend to destabilize the economy.
 Keywords: Bertrand duopoly game, discrete dynamical system, heterogeneous expectations, stability, chaotic behavior

Merger under horizontal and vertical product differentiation

AbstractThis paper studies the possibility of a merger when firms are asymmetric in marginal costs and produce vertically and horizontally differentiated products. The merger of two firms that produce the better‐quality products (w.r.t. third firm) is possible, if the quality difference (net of cost) or the horizontal product differentiation between the firms that merge is high. If the quality difference (net of cost) between the merged firms and the non‐merged firm increases, then a merger is possible if the quality difference (net of cost) and the horizontal product differentiation of the merged firms are significantly high.

High-speed rail pricing: Implications for social welfare

This paper studies the competition between air transport and high-speed rail (HSR) when HSR adopts fixed pricing, and investigates the welfare effect of a reform to change HSR price from fixed to variable. We find that, first, due to the demand-side network effect, HSR traffic may increase with the fixed price. Furthermore, when the HSR operator is a social welfare maximizing monopoly, consistent with general industrial organization theory, social welfare will always increase if HSR moves from fixed price to variable price. However, when the HSR operator maximizes its profit or a weighted sum of profit and social welfare, or when the HSR operator and the airline compete, because of the interaction between the air and HSR services and the horizontal product differentiation of HSR services, social welfare may be greater under the fixed price if that fixed price is sufficiently low.

The perverse effect of environmental regulation on emissions: The role of product‐mix changes

AbstractWe study the effect of environmental regulation (taxation) on emissions when the only available abatement method consists of product‐mix changes. Firms choose to produce one or both varieties of a product—a pollution‐intensive (dirty) and a non‐pollution‐intensive (green)—and compete in a differentiated Cournot duopoly. We characterize the equilibrium market structure as a function of the tax rate and show that increases in the tax can promote product‐mix changes that lead to a jump in emissions for some tax range, an effect we call the perverse effect of taxation. Our work emphasizes the key role horizontal product differentiation in this process and shows that the perverse effect does not require the presence of vertical product differentiation. Further, the perverse effect of taxation is especially strong in the presence of incomplete regulation, that is, when only one of the markets is subject to taxation.

Continuous spatial monopolistic competition: matching goods with consumers

Our novel approach enriches the general additive monopolistic competition model with a space of product characteristics: consumers’ “ideal varieties”. This paper bridges two traditions in modelling markets with horizontal product differentiation: the Hotelling’s (Econ J 39(153):41–57, 1929) “address economy” and Chamberlinian Dixit–Stiglitz monopolistic competition. Unlike Hotelling, our partially localised competition involves intersecting zones of service among producers. When population grows, increasing/decreasing elasticity of elementary utility governs increasing/decreasing prices. Increasing market size induces an increase in the firm density, but with the presence of transport cost, the firm’s range of service decreases, consumers concentrate their consumption closer to their ideals, and there are savings in transport costs. Thereby, finer matching among buyers/sellers becomes the important welfare benefit from a thicker market. That is, our model sets a finer matching of goods to tastes as a new source of gains rather than variety being the only reason for gains. Free entry remains socially excessive, under natural preferences.

Multi-stage strategic trade policy in a differentiated duopoly

We consider a three-stage, non-cooperative game between two countries and two firms (duopoly) under a “reciprocal market model” to identify the optimal trade policy in the presence of tariffs and subsidies, but also allowing each country to commit to free trade. Even in the presence of demand uncertainty and horizontal product differentiation, it is established that there always exists a subgame perfect equilibrium in which one of the countries chooses protection while the other country chooses free trade.

Multimarket competition effects on product line decisions – A multi-objective decision model in fast moving consumer goods industry

In a multimarket competition, firms experience increased contacts with competitors under various product-geographic markets, exhibiting mutual forbearance, which in turn deters firms to venture into product proliferation. However, firms do engage in the same through horizontal product differentiation through 'brand extensions.' Since marketers face imprecise goals, we propose a multi-objective product line decision model for pruning or continuing product lines. Specifically, this is done by using a fuzzy goal-programming method while validating it using a dataset (comprising of eighty thousand households) from the Indian tea industry. Our findings reveal that in the festive season, a firm should only focus on limited brands and prune the rest to maximize its revenue while increasing the spending on advertising and the sales and distribution overheads. However, during the end of the financial quarter, the focus should be on achieving targets by maintaining a broader product portfolio.

Recommendations in credence goods markets with horizontal product differentiation

Abstract I experimentally analyze whether the introduction of watchdogs and the revelation of sellers’ investment decisions can improve the market outcome in credence goods markets with horizontal product differentiation. Sellers can always give advice, yet they only observe consumers’ valuations if they invest. I find that in the absence of watchdogs and with concealed investment decisions, both prices and investment rates are low and sellers give selfish advice. Each measure alone is not sufficient to improve recommendations; only the joint introduction has a significant positive impact on both quality and frequency of recommendations, but leaves welfare unaffected.