Vertical differentiation,product innovation,and dynamic competition

This paper presents an infinite horizon dynamic model in which two firms compete in a market vertically differentiated by the qualities of their products and consumers have heterogeneous preferences for quality. Given the product qualities offered, the firms engage in price competition that segments the market. In each period each firm can spend on product innovation that if successful increases the quality of its product. Three types of Markov perfect equilibria are identified. A running–coasting equilibrium exhibits increasing quality dominance with one firm undertaking innovation and the other coasting to free ride on the innovation by the first firm. The firm that coasts can have the larger dynamic payoff, so quality dominance does not imply payoff dominance. A second is a leap‐frog equilibrium in which the trailing firm undertakes innovation to leap into the lead. The trailing firm never innovates solely to narrow the gap with the leader, so catch up strategies are never used. In the third both firms undertake innovation, but if both have innovation successes, product differentiation remains the same and profits are reduced by the cost of innovation. The rivalry between Intel and AMD in microprocessors for personal computers provides a motivating example.     

A Positive Theory of Moral Management, Social Pressure, and Corporate Social Performance

This paper provides a theory of firm behavior motivated by moral duty, self-interest, and social pressure. A morally managed and a self-interested firm compete in a market in which their corporate social performance (CSP) provides product differentiation. Some citizens have altruistic or warm glow preferences for products with associated CSP, personal giving to social causes, holding shares in firms providing CSP, and contributing to social pressure to increase CSP. Social pressure is delivered by an activist NGO funded by voluntary contributions by citizens. The model characterizes an equilibrium in the product market, the capital market, and the market for social pressure. The equilibrium establishes a price for CSP and for activist-induced social pressure. The theory provides predictions of the market values of firms, the prices of products, firm profits, target selection, contributions to the activist, and the amount of CSP supplied. For example, if citizens do not distinguish between morally motivated CSP and CSP induced by social pressure, the activist is more likely to target the softer, morally motivated firm. Higher quality activists are better funded, target self-interested firms, and obtain greater corporate social performance. Lower quality activists target morally managed firms.     

Spatial duopoly with discriminatory pricing

The concept and existence of an equilibrium is established for profit maximizing competitors whose decisions involve choices of both delivered price schedules and firm locations. Each firm faces a production function; each is allowed to locate in the plane and to set discriminatory prices. Any transport cost function that is continuous in the firm location variable may be used. It is shown that the locations of the two firms are in equilibrium if each firm is minimizing social cost (i.e., the total cost to the firms of supplying the market with the good it demands is minimized) with respect to the opponent's fixed location.     

Endogenous mechanisms and Nash equilibrium in competitive contracting games

We model strategic competition in a market with asymmetric information as a noncooperative game in which each firm competes for the business of a buyer of unknown type by offering the buyer a catalog of products and prices. The timing in our model is Stackelberg: in the first stage, given the distribution of buyer types known to all firms and the deducible, type-dependent best responses of the agent, firms simultaneously and noncooperatively choose their catalog offers. In the second stage the buyer, knowing his type, chooses a single firm and product-price pair from that firm’s catalog. By backward induction, this Stackelberg game with asymmetric information reduces to a game over catalogs with payoff indeterminacies. In particular, due to ties within catalogs and/or across catalogs, corresponding to any catalog profile offered by firms there may be multiple possible expected firm payoffs, all consistent with the rational optimizing behavior of the agent for each of his types. The resolution of these indeterminacies depends on the tie-breaking mechanism which emerges in the market. Because each tie-breaking mechanism induces a particular game over catalogs, a reasonable candidate would be a tie-breaking mechanism which supports a Nash equilibrium in the corresponding catalog game. We call such a mechanism an endogenous Nash mechanism. The fundamental question we address in this paper is, does there exist an endogenous Nash mechanism—and therefore, does there exist a Nash equilibrium for the catalog game? We show under fairly mild conditions on primitives that catalog games naturally possess tie-breaking mechanisms which support Nash equilibria.     

Imitation and price competition in a differentiated market

We study the stable market outcome that evolves in a spatially differentiated market when price-competing firms choose actions by imitation of the most profitable firm. We compare and contrast the stable outcomes under two imitation procedures: one, where each firm immediately imitates the most profitable firm, and the other when a firm imitates another firm only if it is more profitable while being “sufficiently similar” (in context of the market segment it operates in) or “sufficiently close”. In either case, the symmetric pure strategy Nash equilibrium is always a stable outcome. However, when imitation of the most profitable firm is immediate and market differentiation is ‘moderate’, states with prices lower than the Nash equilibrium are also stable. In contrast, when imitation of the most profitable firm is more gradual and market differentiation is below a threshold, states with prices above the Nash equilibrium are also stable. Thus, while competitive evolutionary pressure in this imitation based model does result in the Nash equilibrium always being stable, other outcomes may be stable as well. Interestingly, the states that are stable under gradual imitation give the firms a higher profit than the stable states under immediate imitation.     

The role of debt and bankruptcy statutes in facilitating tacit collusion

Using a two‐period model this paper examines the quantity decisions of leveraged duopolists that are vulnerable to bankruptcy in the first period. When the firms have symmetric costs, a bankrupt firm reorganizes under Chapter 11. If a Chapter 11 firm experiences marginal cost relief, each firm produces a collusive output in period one in order to prevent its rival's financial demise. When the firms have asymmetric costs, the less efficient firm is liquidated under Chapter 7 upon bankruptcy. A predatory equilibrium exists, whereby the inefficient firm is driven from the market. Copyright © 1999 John Wiley & Sons, Ltd.     

Is the Competitor of my Competitor also my Competitor?

This paper presents several results on multimarket competition. First, whenever a firm faces multimarket competitors that sell goods in markets to which the firm itself has no access, the firm gains a strong incentive to expand production in its own market(s). In the capacity choice model, such a firm builds larger than Cournot capacity and pushes its competitors towards other markets. Consumers always benefit from multimarket competition. In asymmetric market structures, some firms may also benefit from multimarket arrangements, but in symmetric ones, all firms are necessarily harmed by it. Second, the intensification of indirect competition is not necessarily bad for the firm. It may be the case that, the more competitors its competitors have, the higher the firm’s profit. Finally, this model also has a multiproduct interpretation which suggests that a merger of single‐product firms may be beneficial or harmful from a social welfare perspective, depending on whether the new entity will compete with several single‐product firms or another multiproduct one.     

Bargains Followed by Bargains: When Switching Costs Make Markets More Competitive

In markets where consumers have switching costs and firms cannot price‐discriminate, firms have two conflicting strategies. A firm can either offer a low price to attract new consumers and build future market share or a firm can offer a high price to exploit the partial lock‐in of their existing consumers. This paper develops a theory of competition when overlapping generations of consumers have switching costs and firms produce differentiated products. Competition takes place over an infinite horizon with any number of firms. This paper shows that the relationship between the level of switching costs, firms' discount rate, and the number of firms determines whether firms offer low or high prices. Similar to previous duopoly studies, switching costs are likely to facilitate lower (higher) equilibrium prices when switching costs are small (large) or when a firm's discount rate is large (small). Unlike previous studies, this paper demonstrates that the number of firms also determines whether switching costs are pro‐ or anticompetitive, and with a sufficiently large (small) number of firms switching costs are pro‐ (anti‐) competitive.     

Does Competition Make Firms More Flexible? A Study of Limited Managerial Cognition

A model of procedural decision making in firms is combined with an oligopoly model to study the effect of limited managerial cognition on firm flexibility. It is argued that a firm may vary its flexibility, and, hence, that there exists a trade-off between decision-making costs and costs due to imperfect adjustment to the environment. The main conclusions are the following: (1) The level of flexibility chosen by firms tends to be too low, from a social welfare point of view. (2) Entry reduces firm flexibility. Aggregated flexibility in the market may, however, increase in which case consumers are unambiguously better off. (3) Integration of isolated markets increases firm flexibility and consumer welfare.     

Leveraging of Reputation through Umbrella Branding: The Implications for Market Structure

The Klein–Leffler model explains how fear of reputation loss can induce firms to produce high‐quality experience goods. This paper shows that reputation can be leveraged across products via umbrella branding, but only by a firm with a monopoly on at least one product. Such a firm may be able to capture a market by using umbrella branding to make high quality credible at a lower price than the incumbent competitive firms. If monopolists compete for this capture, consumers are left better off than if the market remained competitive, in some cases even though the price increases.     

Choosing the Quality of the Fit between Complementary Products

In this paper, I examine how firms should position their complementary products. I assume that there are two competing firms, each producing two complementary products. Each firm decides whether to employ strategies that enhance the quality of the fit (the degree of complementarity) between its pair of complementary products before competing in prices. The consumers have heterogeneous tastes for the four possible bundles. They are willing to pay a price premium in order to purchase a bundle from the same firm if this firm chose to make such bundle more attractive. I find that increasing the degree of complementarity between a firm's complementary products intensifies price competition and often leads to smaller profits. Only when complementarity‐enhancing strategies significantly increase the demand for a firm's matching bundle, does the firm benefit from employing them. The highest profits for both firms are obtained when both firms do not employ complementarity‐enhancing strategies. Deteriorating the quality of the fit between one's own and a rival's complementary products is never profitable.     

Economics of total quality management

This paper presents two models of the economics of total quality management. In the first, the concept of quality management is viewed as a technological innovation that requires investment. To reduce cost and improve quality, firms must make investments that are largely sunk. The effect of market competition on quality related technology investments is studied. Several results follow. With new quality technologies, price falls, quality rises and average cost declines. Firms must anticipate rivals' technology choices and the market prices when justifying quality technology investments. When all firms quickly adopt quality technology, returns of such investments are normal, that is, have a zero net present value. However, firms that do not invest in quality related technology are forced from the market. A firm that is faced by competitors that are slow to adopt quality related technology, can earn positive returns by early adoption. The firm invests more in quality related technology, and produces higher quality products, charges a higher price and earns higher profits than competitors. The firm's quality, price and profit advantages persist over time. In the second model, we show that firm value increases when customer satisfaction is used as an objective by aligning incentives. This explains the common use of customer satisfaction measures in TQM programs.     

Knowledge capital,CEO power,and firm value: Evidence from the IT industry

Disruptive innovation dramatically changes the demand of a product market in the information technology (IT) industry. In response to the impact of disruptive innovation, IT firms that may be eliminated from the competitive race actively develop innovative products and adjust their operating strategies to strengthen their survivability in the fiercely competitive market. Thus, this study explores the factors that affect firm value in the IT industry under the impact of disruptive innovation. The empirical results reveal that knowledge capital and CEO power play crucial roles in explaining firm value. IT firms with powerful CEOs and increased knowledge capital have high firm values. The effects of knowledge capital and CEO power on firm value are especially significant for founder and duality CEO firms. Furthermore, the influence of CEO power is more prominent in periods of financial crisis.     

Are the ‘Big Six’ ‘big’ in Belgium?

Studies in the United States, Europe and Australia have shown that the market for audit services is highly concentrated and largely dominated by the same ‘Big Six’ international audit firms. This paper measures the degree of concentration in the Belgian audit market through an empirical study of the number of professionally qualified auditors employed by each audit firm and some characteristics of their clients. Our calculations show that the concentration ratios, however measured, are low when compared with other countries, possibly due to the low value attached to the certification of financial statements by a professionally qualified auditor. This lack of importance can be explained by characteristics of the Belgian environment (e.g. a relatively passive capital market, dominated by a few large holding companies) which may induce companies to chose cheaper (domestic) audit firms. We also calculate Spearman rank correlations between the rankings of the audit firms based upon the different audit firm revenue proxies. All the correlations show it is of no importance which measure is used to rank audit firms.     

Dynamic Competition with Experience Goods

This paper considers dynamic competition in the case in which consumers are only able to learn about their preferences for a certain product after experiencing it. After trying a product a consumer has more information about that product than about untried products. When competing in such a market firms with more sales in the past have an informational advantage because more consumers know their products. If products provide a better-than-expected fit with greater likelihood, taking advantage of that informational advantage may lead to an informational disadvantage in the future. This paper considers this competition with an infinite horizon model in a duopoly market with overlapping generations of consumers. Two effects are identified: On one hand marginal forward-looking consumers realize that by purchasing a product in the current period will be charged a higher expected price in the future. This effect results in reduced price sensitivity and higher equilibrium prices. On the other hand, forward-looking firms realize that they gain in the future from having a greater market share in the current period and compete more aggressively in prices. For similar discount factors for consumers and firms, the former effect is more important, and prices are higher the greater the informational advantages. The paper also characterizes oscillating market share dynamics, and comparative statics of the equilibrium with respect to consumer and firm patience, and the importance of the experience in the ex post valuation of the product.     

Choosing not to compete: Can firms maintain high prices by confusing consumers?

Firms with very similar products often present their products in different ways. This makes it difficult for consumers to find out which product fits their needs best, or which one is the cheapest. Why is there no convergence toward common ways to present products? Is it possible for firms to maintain high prices by confusing consumers? We run a market experiment to investigate those questions. In our market, firms choose how to present their products in addition to choosing their price. We find that firms maintain different ways to present their products and that this allows them to maintain high prices. This behavior is not consistent with competitive behavior, such as when firms adopt best responses to each other, imitate the most successful firm, or learn the best strategy over time. Rather, our results are only consistent with cooperation between firms. Firms cooperate by not imitating the way other firms present their products. Cooperation is maintained by the threat of tough competition if a firm makes its product easy to compare with others. Firms are all the more likely to maintain such cooperation if their products do not actually differ much. This is because in that case, maintaining differences in the presentation of their products is the only way to maintain profits.     

On Some Procedures of Forming a Multipartner Alliance

In the article, we study two different ways of forming multipartner alliances between firms with the central idea that procedure is an important factor in multipartner alliance formation. In the first procedure, an alliance is formed simultaneously, while in the second procedure (step-by-step) members are added one by one. In the model we present, each firm is assumed to have a multidimensional maneuvering space, which consists of all alliance positions acceptable to the firm, and an ideal position in this space. Alliances will form between the firms whose maneuvering spaces overlap. The results of the analysis confirm that procedure is an important factor in multipartner alliance formation. Nevertheless, if ideal positions of firms are acceptable to all alliance partners, then the result of alliance formation does not depend on procedure. In addition, it is shown that it can be disadvantageous to be a first mover. Finally, we are able to provide sufficient conditions under which one procedure is preferred in a three-partner case. More specifically, a firm with its ideal position acceptable to the two other firms may prefer the simultaneous procedure to being a late mover if (1) there is a certain balance in the firms' degree of flexibility and their power and (2) if the agreed alliance position of the two other firms is acceptable to the firm in question.     

Disclosure Policy in a Mixed Market

This paper investigates the optimal disclosure strategy for private information in a mixed duopoly market, where a state-owned enterprise (SOE) and a joint-stock company compete to supply products. I construct a model where the two firms compete in either quantity or price, and uncertainty is associated with either marginal cost or market demand. The model identifies the optimal disclosure strategies that constitute a perfect Bayesian equilibrium by type of competition and uncertainty. In Cournot competition, both firms disclose information under cost uncertainty, while only the SOE or neither firm discloses information under demand uncertainty. Alternatively, in Bertrand competition, only the joint-stock company discloses information under cost uncertainty or demand uncertainty. Recently, developed countries have required the same level of disclosure standards for SOEs as for ordinary joint-stock companies. The findings described in this paper warn that such mandatory disclosure by SOEs can trigger a reaction by joint-stock companies, putting the economy at risk of a reduction in welfare.     

Horizontal Integration Between Brand and Generic Firms in the Pharmaceutical Industry

This paper asserts that brand pharmaceutical firms (those mostly involved in the invention and production of new drugs) engage in a set of complementary activities that are different from those of generic pharmaceutical firms (those that primarily make off-patent medicines). Complementarities of the Milgrom-Roberts variety within, but not across, these two kinds of firms make it more efficient for pharmaceutical firms to specialize in either brand or generic production. Using FDA data, I show that this is indeed the case. I then examine the firms that produce both types of drugs to see if there are market-level strategic synergies between brand and generic products. I find generic entrants that belong to a corporation that owns the brand in the market are (1) not more likely to enter, (2) not more likely to be approved faster, and (3) not more likely to deter other generics from entering. Thus the advantage, or synergy, from mixing brand and generic activities in one corporation must arise elsewhere in the operations of the firm. If not, the integrated pharmaceutical firm is not the most efficient organizational form for the production of ethical drugs.     

An analysis of firm and market volatility

In this paper, using time series data for the period 2 January 1998 to 31 December 2008 for 560 firms listed on the NYSE, we examine whether firm volatility is related to market volatility. The main contribution of this paper is that we develop an analytical framework motivating the firm-market volatility relationship. We present three new findings on volatility. First, we discover significant evidence of common volatility; for 12 out of 14 sectors, market volatility has a statistically significant effect on firm volatility for at least 50 percent of firms. Second, we discover significant evidence of size effects: for small-sized firms, there is weak evidence of commonality in volatility, while for large-sized firms there is high evidence (for as much as 75 percent of firms) of commonality in volatility. Third, we find that market volatility predicts firm volatility for firms belonging to five of the 14 sectors.