Intense Price Competition Research Articles

Differentiate or Imitate?: The Role of Context-Dependent Preferences

Conventional wisdom, derived from standard economic theory, is that affirm should differentiate itself from its rivals to mitigate intense price competition. Yet there are many examples of firms positioning themselves to mimic their rivals. In this paper we examine the role of context-dependent preferences in explaining this phenomenon. Behavioral researchers have long argued that consumers consider not only the absolute utility of a product but its utility relative to a reference in the choice set as well. Using this premise we construct a game theoretic model of competition between two firms. We consider two horizontally differentiated firms where some consumers own the product of one firm while the rest own the other firm's product. One firm upgrades its existing product by adding a new feature. In the absence of any cost or capability constraints, to protect its competitive position, the other firm would prefer to update its product by adding a differentiated new feature. We show that if consumers' preferences are context-dependent, then under some conditions the second mover would tend to imitate the first mover by adding the same feature even when with no cost disadvantage it can differentiate itself. This happens because context-dependent preferences cause consumers to dislike brands that are very differentiated from one another and value common features among the brands more than distinct features. As a result of this, when consumers exhibit context-dependent preferences and the proportion of second-mover's consumers who enjoy the first mover's new feature is not too small, if the second mover mimics the first mover both firms can charge higher prices for their upgraded products. This outcome, in turn, leads the first mover to pick a new feature to upgrade its existing product such that it would encourage the second mover to imitate itself. Therefore, unlike the extant literature, our analysis shows that mimicking/co-location does not necessarily require a tradeoff between higher demand and lower prices.

Equity benefits of smaller wine regions and lifestyle segmentation

Historically, the wine industry has considered product quality to be the driver for increasing competitiveness, with wine quality the rule rather than the exception. The result is that consumers alternate between wines that communicate only on quality, exposing producers to intense price competition. Little has been done to determine the value that consumers place on wine regions, but research does suggest that the value consumers place on specific origins go deeper than merely quality and price, reflecting other dimensions such as emotional or social associations. This study examines dimensions of wine region brand equity, measured through benefits sought by consumers. A survey was conducted in the United States to identify drivers of preferences and to determine relationships that may exist between those drivers, origin preferences and consumer lifestyles. The findings suggest that brand equity of small wine regions stems from five consumer motivational factors and these factors are strong determinants of consumer preferences. Thus, connecting these factors to consumer lifestyle, demographic and geographic profiles facilitates more focused marketing strategies.

STRATEGIC INFORMATION DISCLOSURE: THE CASE OF MULTIATTRIBUTE PRODUCTS WITH HETEROGENEOUS CONSUMERS

We examine the incentives for firms to voluntarily disclose otherwise private information about the quality attributes of their products. In particular, we focus on the case of differentiated products with multiple attributes and heterogeneous consumers. We show that there exist certain configurations of consumers' multidimensional preferences under which a firm, no matter whether producing a high‐ or low‐quality product, may choose not to reveal the quality even with zero disclosure costs. The failure of information unraveling arises when providing consumers with more information results in more elastic demand, which triggers more intensive price competition and leads to lower prices and profits for competing firms. As a result, the equilibrium in which disclosure is voluntary may diverge from that in which disclosure is mandatory. (JEL L15, L5)

Vertical Differentiation with Variety-Seeking Customers

We analyze price and quality competition in a vertically differentiated duopoly in which consumers have a preference for variety. The variety-seeking preferences are a consequence of diminishing marginal utility for repeated consumption experiences of the same product. We find that variety-seeking preferences can either soften or intensify price competition, depending on the range of feasible qualities and the strength of consumer preference for variety. When the range of feasible qualities is small enough, prices are higher than would be obtained in the absence of variety seeking - leading to higher profits - and competing firms choose to minimally differentiate themselves from each other. On the other hand, if qualities are exogenously set to be different enough from each other then stronger preferences for variety are associated with moreintense price competition and lower profits

A NOTE ON PRODUCT DIFFERENTIATION IN A LINEAR CITY AND WAGE BARGAINING

ABSTRACTEconomides (Economics Letters, 1986, 21, pp. 67–71) has shown that within a linear city an equilibrium exists in a two‐stage location–price game when the curvature of the transportation cost function is sufficiently high. One important point is that not all of these equilibria are at maximal differentiation. In this paper, we include an additional stage with decentralized wage bargaining. This intensifies price competition resulting in locations that are nearer to the extremes of the city. The magnitude of this effect depends on the bargaining power of the unions. Contrary to the model with exogenously given costs, if unions are sufficient strong all price equilibria in pure strategies are at maximal differentiation. With a low parameter for the curvature of the transportation cost function unions can improve the location decision from a social viewpoint.

From under the shadows: developing awareness in a conventional market with a product less recognized

From under the shadows: developing awareness in a conventional market with a product less recognized Nelson Barber, Janis DonovanWhittemore School of Business, University of New Hampshire, Durham, NH, USAAbstract: The wine industry has considered product quality as the benchmark driving ­competitiveness, with wine quality the target standard. This focus on quality exposes producers to intense price competition with consumers alternating between wines. Some research has been done on country of origin suggesting the value consumers place on specific origins goes deeper than quality and price, inferring the presence of other dimensions such as emotional, economic, and social associations. However, little has been done to determine the value consumers place on the sub-wine regions of these larger countries. This study examines dimensions of wine region brand equity, by analyzing benefits sought by consumers. Data was collected through a survey conducted in the United States which identified drivers of preferences for wine regions and relationships that may exist between those drivers and wine region preferences. The findings suggest brand equity of small wine regions results from consumer motivational factors and these factors are determinants of consumer preferences. Linking these factors to consumer, demographic and location allows for direct marketing strategies.Keywords: wine region brand equity, consumer, gender, millennial

Competitive Effects of Mass Customization

Earlier theoretical literature on mass customization maintains that customization reduces product differentiation and intensifies price competition. In contrast, operations management studies argue that customization serves primarily to differentiate a company from its competitors. Interactive involvement of the customer in product design creates an affective relationship with the firm, relaxing price competition. This paper provides a model that incorporates consumer involvement to explain the phenomena described in the operations management literature. Two firms on the Hotelling line compete for a continuum of consumers with heterogeneous brand preferences. An exogenously given fraction of consumers is potentially interested in customization. Consumer benefits from customization are the rewards from a special shopping experience and the value of product customization (better fitting product); these benefits are higher for consumers located closer to the customizing brand. When a consumer purchases a customized product, he incurs the waiting cost. The firms decide whether to offer customization, then engage in price competition. I show that customization increases the stickiness of a consumer to the customizing firm, leading to less intense price competition. As mass customization becomes more efficient (the lead time goes down and/or the sunk costs decrease), customization by one or both firms occurs in equilibrium. I perform comparative statics analysis with respect to the fraction of consumers potentially interested in customization.

Wine packaging: marketing towards consumer lifestyle to build brand equity and increase revenue

The wine industry considered product quality as key to increasing competitiveness. However, when wines are perceived quality neutral, regardless of other existing differences, consumers will substitute one wine for another exposing producer to intense price competition. To differentiate wines, a determination of what values consumers place on wine packaging may be established in other dimensions such as environmental or functional benefits with current research suggesting these values go further than quality and price. Linking the techniques of revenue and brand management may provide a winery with revenue growth and customer loyalty. This study examined dimensions of wine packaging equity, benefits wine consumers seek and the motivational preferences and relationships between consumer lifestyles. Results indicated that wine packaging equity originates in four motivational factors that are strong predictors of preferences. Linking dimensions of packaging equity to consumer lifestyle, demographic and behavioural variables allow marketers to tailor communication strategies closely to markets for potential revenue enhancement.

Personalized Pricing and Quality Customization

We embed the principal–agent model in a model of spatial differentiation with correlated consumer preferences to investigate the competitive implications of personalized pricing and quality allocation (PPQ), whereby duopoly firms charge different prices and offer different qualities to different consumers, based on their willingness to pay. Our model sheds light on the equilibrium product‐line pricing and quality schedules offered by firms, given that none, one, or both firms implement PPQ. The adoption of PPQ has three effects in our model: it enables firms to extract higher rents from loyal customers, intensifies price competition for nonloyal customers, and eliminates cannibalization from customer self‐selection. Contrary to prior literature on one‐to‐one marketing and price discrimination, we show that even symmetric firms can avoid the well‐known Prisoner's Dilemma problem when they engage in personalized pricing and quality customization. When both firms have PPQ, consumer surplus is nonmonotonic in valuations such that some low‐valuation consumers get higher surplus than high‐valuation consumers. The adoption of PPQ can reduce information asymmetry, and therefore sellers offer higher‐quality products after the adoption of PPQ. Overall, we find that while the simultaneous adoption of PPQ generally improves total social welfare and firm profits, it decreases total consumer surplus.

Creating commitment and loyalty behavior among retailers: what are the roles of service quality and satisfaction?

As a result of weakening brand image/loyalty, little differentiation, and intense price competition, manufacturers are now increasingly pressed to ensure retailers’ shelf space and/or salesperson attention. This research contributes to the literature by empirically examining an underrepresented body of literature in the B2B context—retailer loyalty. Specifically, this study fills a gap by investigating retailer evaluations of the technical and relational dimensions of a manufacturer’s order fulfillment service quality as predictors of retailer satisfaction, affective versus calculative commitment, and ultimately loyalty behavior. Results suggest that both technical and relational order fulfillment service quality influence satisfaction, which in turn positively affects both affective and calculative commitment. By separating the affective and calculative dimensions, loyalty behavior is associated directly only with affective commitment. Further examination reveals that relational order fulfillment service quality has a direct impact on affective commitment. When the sample was split based on “share of wallet,” results suggest that satisfaction impacts both affective and calculative commitment, regardless of “share of wallet.” For “high share” retailers, the positive relationship of calculative to affective commitment creates an indirect route (through affective commitment) by which calculative commitment affects behavioral loyalty.

A dynamic model for advertising and pricing competition between national and store brands

Abstract We study the relationship between the pricing and advertising decisions in a channel where a national brand is competing with a private label. We consider a differential game that incorporates the carryover effects of brand advertising over time for both the manufacturer and the retailer and we account for the complementary and competitive roles of advertising. Analysis of the obtained equilibrium Markov strategies shows that the relationship between advertising and pricing decisions in the channel depends mainly on the nature of the advertising effects. In particular, the manufacturer reacts to higher competitive retailer’s advertising levels by offering price concessions and limiting his advertising expenditures. The retailer’s optimal reaction to competitive advertising effects in the channel depends on two factors: (1) the price competition level between the store and the national brands and (2) the strength of the competitive advertising effects. For example, in case of intense price competition between the two brands combined with a strong manufacturer’s competitive advertising effect, the retailer should lower both the store and the national brands’ prices as a reaction to higher manufacturer’s advertising levels. For the retailer, the main advantage from boosting his competitive advertising investments seems to be driven by increased revenues from the private label. The retailer should however limit his investments in advertising if the latter generates considerable competitive effects on the national brand’s sales.

Market Research and Innovation Strategy in a Duopoly

We model a duopoly in which ex ante identical firms must decide where to direct their innovation efforts. The firms face market uncertainty about consumers' preferences for innovation on two product attributes and technology uncertainty about the success of their research and development (R&D) investments. Firms can conduct costly market research before setting R&D strategy. We find that the value of market information to a firm depends on whether its rival is expected to obtain this information in equilibrium. Consequently, one firm may forgo market research even though its rival conducts such research and learns the true state of demand. We examine both vertical and horizontal demand structures. With vertical preferences, firms are a priori uncertain about which attribute all consumers will value more. In this case, a firm that conducts market research always attempts innovation on the attribute it discovers that consumers prefer and expends more on R&D than a rival that has not conducted market research. With horizontal preferences, distinct segments exist—each caring about innovation on only one attribute—and firms are a priori uncertain how many consumers each segment contains. In this case, a firm that conducts market research may follow a niche strategy and attempt innovation to serve the smaller segment to avoid intense price competition for the larger segment. A firm that conducts market research may therefore invest less in R&D and earn lower postlaunch profits than a rival that has forgone such research.

A Theory of Combative Advertising

In mature markets with competing firms, a common role for advertising is to shift consumer preferences towards the advertiser in a tug-of-war, with no effect on category demand. In this paper, we analyze the effect of such “combative” advertising on market power. We show that, depending on the nature of consumer response, combative advertising can reduce price competition to benefit competing firms. However, it can also lead to a procompetitive outcome where individual firms advertise to increase their own profitability, but collectively become worse off. This is because combative advertising can intensify price competition such that an “advertising war” leads to a “price war.” Similar to price competition, advertising competition can result in a prisoner's dilemma where all competing firms make less profit even when the effect of each firm's advertising is to enhance consumer preferences in its favor. Given such procompetitive effects, we further show that cost of combative advertising could be a blessing in disguise—higher unit cost of advertising resulting in lower equilibrium levels of advertising, leading to higher prices and profits. We conduct a laboratory experiment to investigate how combative advertising by competing brands influences consumer preferences. Our experimental analysis offers strong support for our conclusions.

Distance decreases with differentiation: Strategic agglomeration by retailers

Theory predicts intense price competition results when firms cluster with rivals. Yet, strong evidence of clustering is found in previous empirical research. Researchers typically measure clustering by comparing observed location patterns to random assignment. The random assignment benchmark does not, however, account for zoning and geography and therefore might overstate the extent of strategic agglomeration. As evidence, we find that public elementary schools cluster more than random, not because of agglomeration economies, but due to demand density and limited location options. We argue that a better measurement of strategic agglomeration is to compare across product markets with similar zoning and other location restrictions but different benefits from agglomeration. We use L-function analysis of five product markets in five cities. We find that retailers with greater ability to differentiate their products are more likely to strategically cluster.

Economic incentives to adopt electronic payment schemes under competition

With advances in information and other technologies, newer forms of electronic payment schemes such as Google Checkout, NetPay, WebMoney, etc., have emerged over the last decade. These payment schemes are cheaper for sellers as compared to traditional payment schemes such as credit cards. Further, the convenience of credit cards over these alternative payment schemes is not valued the same by all consumers. Inspite of the cost differences between these payment schemes and the consumer heterogeneity in their relative valuations, sellers typically charge the same price from consumers irrespective of the payment scheme. We develop an economic model to examine a seller's incentive to offer discounts to consumers to encourage the use of alternative payment schemes. We find that while a monopolistic seller does find it optimal to offer a discount, offers of such discounts are almost never optimal when two vertically-differentiated sellers compete with each other. Overall, we demonstrate that sellers' desire to not intensify price competition may partly explain why they do not encourage use of newer and cheaper alternative payment schemes by offering discounts to consumers.

Platform Competition, Compatibility, and Social Efficiency

We study competitive interaction between two platform providers (such as two suppliers of videogame consoles or operating systems) that mediate between sellers of platform-based products (developers of games or applications) and buyers of such products (users of games or applications). Users and developers first trade with one of the platforms (users purchase videogame consoles and developers software development kits) and then with each other (users buy games from developers). We show that the unique equilibrium under platform compatibility exhibits more intense price competition for developers, softer price competition for users, and higher profits than the symmetric equilibrium under incompatibility (which may involve user subsidization to join a platform). Compatibility leads to higher profits because it induces more entry by developers, lower application prices, and larger user surplus that platforms capture through higher user access prices. Incompatibility, however, naturally gives rise to asymmetric equilibria with a dominant platform that captures all users and earns more than in the compatible equilibrium. The model also allows a detailed analysis of social efficiency, and we show that entry by developers is socially excessive (insufficient) if competing platforms are compatible (incompatible).

Newsvendors Under Simultaneous Price and Inventory Competition

This paper extends the theory of N competitive newsvendors to the case where competition occurs simultaneously in price and inventory. The basic research questions are whether the Nash equilibrium exists in this game, whether it is unique, and how the resulting inventories and prices are affected by competition. Using a novel method, we show the quasiconcavity of the competitive newsvendor's problem and establish the existence of the pure-strategy Nash equilibrium. Through a contraction mapping approach, we develop sufficient conditions for the Nash equilibrium to be unique. We then analyze the properties of the equilibrium and compare it with the optimal solution for the (noncompeting) price-sensitive newsvendor. We prove that at a symmetric equilibrium, retail prices and safety stocks strictly increase with the proportion of a newsvendor's unsatisfied customers that switch to a competitor, but strictly decrease with the intensity of price competition. Total inventories, on the other hand, increase with the intensity of price competition. Furthermore, the competitive equilibrium never has lower safety stocks and higher retail prices (a situation that definitely hurts the customers) than the solution for noncompetitive newsvendors.

Price Transparency and Consumer Naivety in a Competitive Market

Despite intense price competition firms obfuscate product information when it is relatively costless to reveal, contrary to neoclassical predictions. This paper considers whether firms can profitably conceal (part of) their prices for a homogeneous product when consumers differ in their ability to form expectations of market prices. The model shows that the ability to conceal prices but still attract naive consumers dampens competition and allows prices to be set above marginal cost. This suggests that the European Commission was correct to pass regulations that require airlines to set prices inclusive of taxes, fees and charges, because alternative policies of educating a proportion of naive consumers to become sophisticated or assisting consumers to search the market more effectively could increase prices in some situations.

A Test of the Quality of Concentration Indices

Theory predicts a positive relationship between market concentration and profitability in most scenarios. In empirical work, however, this relation is frequently not found or only a weak connection is observed. We compare the performance of concentration and market share variables, which are generated on the basis of the official industry classification, with information collected directly from firms. Information from companies on the number of competitors, their relative size and the intensity of price competition is highly significant in explaining profit levels, while none of the concentration indices performs well. Hence, the poor quality of industry data is responsible for the loose connection that is usually found between concentration and profitability.

An international empirical analysis of the performance of manufacturers and retailers

Trade press and general arguments from channel members constantly assert that retailers are getting more powerful. Our empirical analysis, however, shows that the retail sector under-performs manufacturers and when measured in terms of shareholder return their performance relative to manufacturers is getting worse over time. We show that this phenomenon, which was first shown to exist in the US in the 1980s and early 1990s, still holds in the late 1990s and the early years of the 21st century and not only in the US but also in Europe. We generate some hypotheses that contribute to explaining our empirical findings. We sketch a variety of structural and strategic factors and find that the intensity of retail price-based competition might be a key and under-appreciated factor. Retailers do seem to be increasing their vertical power, but they find it difficult to hold on to any additional resources they obtain from their suppliers because of intense price competition in the retail sector.