Flirting with the enemy: online competitor referral and entry-deterrence

Internet retailers often compete fiercely for consumers through expensive marketing efforts like search engine advertising, online coupons and a variety of special deals. Against this background, it is somewhat puzzling that many online retailers have recently begun referring their website visitors to their direct competitors. In this paper, using an analytical model, we examine this counterintuitive practice and posit that an entry deterrence motive can potentially explain this marketplace puzzle. Specifically, we develop a model where two incumbents compete for consumers” business while facing a potential entrant who is deciding whether to enter the market. In addition to setting the price, each incumbent firm could potentially display a referral link to its direct competitor. Our analysis reveals that when confronted with a potential entry, an incumbent may refer consumers to its competitor, intensifying the market competition that could result in shutting off the entrant. Furthermore, we show that when referral efficiency is exogenous, it is possible that in equilibrium only one incumbent refers its customers to competitor (i.e., one-way referral) or both incumbents refer their customers to each other (i.e, two-way referral). When referral efficiency is endogenous, the ex-ante symmetric incumbents may choose asymmetric referral efficiencies ex-post. We extend the model in a number of directions including making the entrant share endogenous and allowing incumbents to be asymmetric. Overall, our results indicate that firms may be motivated by entry deterrence to voluntarily refer consumers to their direct competitors even when they are paid nothing for the referral.     

Discriminatory Prices,Predation and Signal-Jamming in a Horizontal Differentiation Model

We study the effects of predation in an asymmetric duopoly model à la Hotelling in which the incumbent is able to price discriminate while the entrant sets a uniform price. We show that when the discount factor is high (low) enough and the incumbent accommodates entrance the incumbent initially sets a uniform price (discriminatory prices) and then engages in price discrimination. Under certain conditions, the entrant prices aggressively in order to discourage predation from the incumbent: predation actually does not occur and all equilibrium prices are lower with respect to the case in which the threat of predation is absent. In a T-period model, we derive conditions under which the equilibrium prices increase over time until they stabilize at the level that would result in the absence of the threat of predation.     

Signaling quality with new product preannouncements: Vaporware and the role of reference quality

This research develops a signaling game that captures the essential dynamics of new product preannouncements (preannouncement/launch/market feedback). New product preannouncements are preannouncing firms' formal efforts to inform their competitors and customers about the future availability, superior quality and introductory price of their upcoming new products. In a market, two firms compete (entrant preannounces and incumbent responds) across two periods. The entrant has private information about the true quality of a new product (the incumbent and customers do not know it), and this informational asymmetry provides the entrant with a preannouncement dilemma. Should the entrant preannounce and, if the entrant does, should the entrant tell the truth about quality? Preannouncements often get customers who might buy now from a competitor to wait for a higher quality to be available. Therefore, the entrant may have an incentive to bluff the quality of a new product in order to enhance the likelihood of customers' waiting. However, because the quality exaggeration is also likely to increase customers' quality expectations, the entrant may suffer a significant sales penalty if the entrant does not deliver the promised quality. Through the signaling game, this paper derives conditions under which such a bluff does/does not put the preannouncing firm at risk (i.e., this paper derives the separating/pooling equilibria that are the focus of signaling games).     

Local competition, entry, and agglomeration

This paper analyzes competition between two spatially differentiated multi-product retailers who encounter entry from a low-cost discounter. We assess how entry affects the pricing of the incumbent stores and the role played by the location of the entrant. Our primary objective is to identify how traditional retailers respond to new forms of low-cost retailing. Results show that post entry, the prices for some products are higher than the pre entry. However, which product prices increase depends on the incumbent’s location. Contrary to conventional wisdom, we find that the store closer to the entrant is better off compared to the incumbent located further away. We empirically demonstrate the main workings of our theory using sales data from several grocery stores that saw entry by discount stores in their trading areas.     

Optimal low-price guarantees with anchoring

Many low-price guarantees are offered by small local firms who compete against much larger rivals. The prices of these larger rivals are often set nationally and thus are independent of local market conditions. Our objective in this paper is to explain why small firms in such environments might nevertheless adopt low-price guarantees. We characterize when offering a low-price guarantee is profitable, and assess which form it should take (i.e.,?conditional on offering a low-price guarantee, should the small firm offer to match or beat its larger competitor??s prices). We also assess the implications thereof (i.e., do the low-price guarantees benefit or harm the small firm??s customers).     

How incumbent firms foster consumer expectations, delay launch but still win the markets for next generation products

Consumers learn quality of many durable products through word-of-mouth information while firms launch new and improved products frequently in these markets. This paper examines firm incentives to invest in R&D to compete for patents in makets where consumers rely on word-of-mouth information and have expectations about the new products before launch. When its loss due to a possible entry is above a threshold, an incumbent has more incentives than a potential entrant to invest in R&D for patents. Moreover, if the current product is more profitable, its true quality is above consumer priors and the quality of the new product is below a threshold, it is optimal for the incumbent to launch the new product after a time lag. The later the optimal time of launch, the greater is the incumbent’s potential loss if entry occurs and greater its incentives is to invest in R&D versus that of the entrants. While potential entrants are generally thought to have more incentives to invest in a drastic innovation which results in a race to launch the new products, we show that the more drastic the innovation, the later the optimal time of launch and greater are the incumbent’s incentives to invest in R&D when the value added of the new product can be conveyed to all the consumers. Only when consumers are uncertain about the value added of the new product, the incumbent’s incentives are lower. We also demonstrate that by promoting consumer expectations about the new product before launch, an incumbent has more time to launch and higher probability of dominating its market.     

Endogenous retailer preferences in intermediate good markets

We model strategic interaction in a differentiated input market as a game among two suppliers and n retailers. Each one of the upstream firms chooses the specification of the input which it will offer.Then, retailers choose their type from a continuum of possibilities. The decisions made in these two first stages affect the degree of compatibility between each retailer's ideal input specification and that of the inputs offered by the two upstream firms. In a third stage, upstream firms compete setting input prices. Equilibrium may be of the two-vendor policy or of the technological monopoly type.     

Entry deterrence/accommodation with imperfect strategic thinking capability

Both through empirical research and laboratory experiments it has been shown that managers are heterogeneous in strategic thinking-i.e., not all the managers can accurately conjecture their competitors’ behavior and actions. In this paper, we examine the entry deterrence/accommodation strategy of an incumbent firm facing a potential entrant that may behave less strategically than the incumbent in the way of conjecturing competitors’ actions and beliefs. We adapt the Cognitive Hierarchy model to capture this heterogeneity among the managers of the entrant firm and the incumbent firm. Surprisingly, we show that the incumbent can deter entry by investing in expanding the market size and the competition may increase the incumbent’s incentive to invest in market expansion. If entry does occur, the market expansion in our model also benefits entrant comparing to the case without market expansion. This feature of our result sets it apart from the standard result in the entry deterrence literature, which tends to suggest that incumbent has to either over-invest in actions harmful to entrant if entry occurs. In our model investing in expanding the market size makes the entrant to update its belief about the incumbent’s strategic thinking capability downward and thus, decreases the entrant’s expected profitability, which in turn deters entry. Our research has important implications especially for emerging markets given that the lack of management talent is a particularly severe problem among local firms in emerging markets and multinational companies pioneer in the emerging markets with great market expansion opportunities have to face the potential entry of local companies.     

To Acquire,or To Compete? An Entry Dilemma

In this paper we address the following question: is it more profitable, for an entrant in a differentiated market, to acquire an existing firm than to compete? We illustrate the answer by considering competition in the banking sector.     

One‐Way Compatibility,Two‐Way Compatibility and Entry in Network Industries

We study the strategic choice of compatibility between two initially incompatible network goods in a two‐stage game played by an incumbent and an entrant firm. Compatibility may be achieved by means of a converter. We derive a number of results under different assumptions about the nature of the converter (one‐way vs two‐way), the existence of property rights and the possibility of side payments. With incompatibility, entry deterrence occurs for sufficiently strong network effects. In the case of a two‐way converter, which can only be supplied by the incumbent, incompatibility will result in equilibrium unless side payments are allowed and the network externalities are sufficiently low. When both firms can build a one‐way converter and there are no property rights on the necessary technical specifications, the unique equilibrium involves full compatibility. Finally, when each firm has property rights on its technical specifications, full incompatibility is observed at the equilibrium with no side payments; when these are allowed the entrant sells access to its network to the incumbent which refuses to do the same and asymmetric one‐way compatibility results in equilibrium.     

Entry mode selection and its impact on an incumbent supply chain coordination

This paper considers a supply chain where a manufacturer sells its product through a retailer. In such a market, a potential entrant can make a substitute product by imitating the incumbent's product and then sells it to the common market with one of three alternative entry modes: (i) selling through the incumbent's retailer, (ii) selling through another independent retailer, or (iii) selling directly to consumers. Faced with the entrant's entry, the manufacturer has managed to offer a value-added service to add to its product's value at a cost. We investigate the entrant's optimal entry mode when the manufacturer offers profit-sharing contracts to the retailer and when it does not, and discuss the impact of the potential invader's entry on the incumbent firms' performances. The results show that: (1) the entrant sells directly to consumers when faced with weak value competition, and sells through another retailer against fierce value competition. (2) If the value competition is relatively fierce and the efficiency of the value-added service is relatively high as well, the incumbent firms can benefit from the new entry. (3) A profit-sharing contract, as a coordination policy, can fully coordinate the incumbent supply chain no matter whether there exists a potential entrant or not, yet the entry can affect the distribution of the profits between the incumbent manufacturer and retailer.     

Agency Model and Wholesale Pricing: Apple versus Amazon in the E-Book Market

Apple’s choice of the agency model (i.e., Apple demands a share from the retail price set by the publishers) when entering the e-book market was surprising because: (i) the upstream firms can accrue all rents in a simultaneous move game if it determines the retail price; and (ii) the incumbent, Amazon, used wholesale pricing arrangements. This paper compares the two different contract types, pure and mixed: one retailer opts for wholesale, the other for the agency model. Departing from a standard and symmetric oligopolistic setup of Bertrand competing retailers and producers, the model accounts for retailers having (a) a significant contribution to the final value and (b) a strategic first-mover advantage. Both conditions combined are necessary (but not sufficient) in order to explain Apple’s choice and the possibility of an asymmetric equilibrium.     

Capacity Constrained Firms and Expansion Subsidies: Should Governments Avoid Generous Subsidies?

This paper examines entry deterrence and signaling when an incumbent firm experiences capacity constraints. Our results show that if the costs that constrained and unconstrained incumbents incur when expanding their facilities are substantially different, separating equilibria can be supported under large parameter values whereby information is perfectly transmitted to the entrant. If, in contrast, both types of incumbent face similar expansion costs, subsidies that reduce expansion costs can help move the industry from a pooling to a separating equilibrium with associated efficient entry. Nonetheless, our results demonstrate that if subsidies are very generous entry patterns remain unaffected, suggesting a potential disadvantage of policies that significantly reduce firms’ expansion costs.     

A reappraisal of strategic trade policies with the endogenous mode of competition under vertical structures

This paper examines the endogenous choice of competition mode with strategic export policies in vertically related markets when each upstream firm located in each country determines the terms of the two-part tariff contract by maximizing generalized Nash bargaining. We show that (i) choosing Cournot (Bertrand) competition is the dominant strategy for both downstream firms when goods are substitutes (complements), which leads Pareto superior regardless of the nature of goods under the optimal trade policies; (ii) irrespective of rival’s competition mode, the optimal trade policy is an export subsidy under Cournot competition and an export tax under Bertrand competition; and (iii) trade liberalization may give rise to changes of competition mode and increase of social welfare.     

The GATS and liberalization in a natural-resource rich country

Abstract

We highlight the role of natural resources in countries that use resource revenues to subsidize employment in state-owned services sectors by developing a model of service provision where domestic incumbents and a foreign entrant compete. We find that when natural resource prices have a higher likelihood of increasing, domestic firms control most of the market share but that industry output drops. However, the output of the services industry rises with domestic firms losing market share when natural resource prices are likely to go down. This suggests that a government focused narrowly only on the growth and development of its economy would prefer services liberalization when natural resource prices are likely to be higher.     

Strategic Use of Analytical CRM in a Market with Network Effects and Switching Costs: Terminating Unprofitable Customer Relationships

Analytical customer relationship management (CRM) systems make firms more informed than ever about their customers. This further gives firms the ability to serve customers selectively in a way that ensures retaining profitable customers and eliminating unprofitable ones. However, when firms of products/services with network effects decide to eliminate unprofitable customers, they may face the risk associated with firing them, which is user-based shrinkage. This risk incurred as a result of network effects has been widely neglected in CRM literature. In this study, considering this risk, we investigate when firms can eliminate unprofitable customers in the competitive market with network effects and consumer switching costs, which often co-exist with network effects, using a game-theoretic model of a duopoly. Our results show that it is not desirable for firms to fire unprofitable customers in the presence of strong network effects or sufficiently low consumer-switching costs. Otherwise, firms can fire unprofitable customers and benefit from the ability to eliminate them. An interesting point is that competing firms can be better off when both have the ability to eliminate unprofitable customers in the presence of moderate switching costs and small network effects.     

Contracting in a Market with Differential Information

Today’s technology allows firms to collect, store and use different types of data. This has prompted a wide discussion on the effects of access to data on competition and consumer welfare. This discussion has also been present in the energy sector in which advanced technology has allowed for the collection of detailed energy consumption data. Prompted by this discussion on the energy sector, this paper studies an industry where two firms have access to the same technology and compete in prices, but one of them has access to better information about customers. The better informed firm obtains a customer contact advantage, whereas the uninformed firm can still offer a menu of prices without being able to pre-identify the customers. We show that the better informed firm is able to exclude the uninformed firm from the market. This result provides policy insights on the usefulness of considering data access models that can ensure non-discriminatory behaviour.

     

Cournot and Bertrand Competition when Advertising Rotates Demand: The Case of Honda and Scion

We develop a model to explain why firm behavior differs in the market for small cars. Firms such as Honda compete in output (Cournot) and produce marketing campaigns with universal appeal, while firms such as Scion compete in price (Bertrand) and produce targeted marketing campaigns. We show that this mixture of Cournot and Bertrand behavior can occur when advertising rotates demand. When behaving as a Cournot-type firm such as Honda, it is more profitable to pursue a mass-market advertising campaign that rotates demand counterclockwise when it faces relatively low unit costs and a flat demand function. When behaving as a Bertrand-type firm such as Scion, it pays to pursue a niche-market advertising campaign that rotates demand clockwise when it faces relatively high unit costs and a steep demand.     

The effect of exogenous product familiarity on endogenous consumer search

When a consumer is familiar with one product but not its competitor, she is faced with a decision: either buy what she knows, or engage in search to learn more. When search is costly, competing firms may attempt to encourage or discourage search by adjusting prices. In this paper we consider how competitive dynamics between two quality differentiated firms are affected if one product enjoys a familiarity advantage. Familiarity is defined as a consumer’s ex-ante knowledge of fit for a particular product. An increase in the level of familiarity for one product allows a firm to charge higher prices since there are more consumers with information on that product relative to the competition. We call this the direct effect of familiarity. However, an increase in familiarity also has an indirect effect, since it gives the rival firm a stronger incentive to decrease price in order to encourage searching, in turn increasing overall competition. The effect of familiarity on profits depends on the magnitudes of these effects, and it is moderated by the level of quality differentiation between products. For very high or very low levels of differentiation, the results are relatively straightforward. However, when the level of differentiation is moderate, the results are more nuanced, with the higher-quality firm realizing higher profits from more familiarity, even if it must lower prices due to the indirect effect. We also find that, contrary to conventional wisdom, overall competition may be higher when firms are more quality differentiated. This is driven by the fact that higher quality differences bolster the indirect effect, with a lower quality firm providing deeper price cuts to counter increased familiarity of a high quality rival. We conclude by examining how changes in the cost of searching impact equilibrium outcomes.

     

Contractual Design as a Determinant of Performance: Evidence from Franchising

This empirical note deals with the contractual design of relationships between producers and retailers. It provides evidence on the links between the features of vertical contracts organizing franchising networks and the performances of these networks. An agency perspective is used to understand the structure of contracts. We focus on the relevance of vertical restraints by the upstream firm to prevent retailers from free‐riding in the distribution networks. From six frequent contractual provisions we distinguish two types of contracts according to the degree of constraint imposed on the franchisees. Econometric estimations carried out on this basis offer evidence consistent with the hypothesis that within franchising systems, more constrained contracts for retailers encourage better performance at the network level.