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.     

Direct Marketing in Oligopoly

We consider a game in which symmetric manufacturers decide whether to set up sites (e.g., web sites) where consumers can buy their products directly. Following this decision, the manufacturers choose quantities to sell to the retailers, and then the manufacturers with direct‐sales sites and retailers choose quantities to sell to the consumers. We show that since an increase in the number of retailers may drive the direct‐selling manufacturers from the retail market, it may raise the retailers’ profit and reduce social welfare. Finally, we discuss two cases: an oligopolistic wholesale market and a market with price competition and differentiated products.     

Nonlinear Pricing and Oligopoly

We consider the general problem of price discrimination with nonlinear pricing in an oligopoly setting where firms are spatially differentiated. We characterize the nature of optimal pricing schedules, which in turn depends importantly upon the type of private information the customer possesses–either horizontal uncertainty regarding brand preference or vertical uncertainty regarding quality preference. We show that as competition increases, the resulting quality distortions decrease, as well as price and quality dispersions. Additionally, we indicate conditions under which price discrimination may raise social welfare by increasing consumer surplus through encouraging greater entry.     

Voluntary Quality Disclosure under Price‐Signaling Competition

We analyze an oligopolistic competition with differentiated products and qualities. The quality of a product is not known to consumers. Each firm can make an imperfect disclosure of its product quality before engaging in price‐signaling competition. There are two regimes for separating equilibrium in our model depending on the parameters. Our analysis reveals that, in one of the separating regimes, price signaling leads to intense price competition between the firms under which not only the high‐quality firm but also the low‐quality firm chooses to disclose its product quality to soften the price competition. Copyright © 2011 John Wiley & Sons, Ltd.     

Exercising Market Power in Proprietary Aftermarkets

Over 20 recent antitrust cases have turned on whether competition in complex durable-equipment markets prevents manufacturers from exercising market power over proprietary aftermarket products and services. We show that the price in the aftermarket will exceed marginal cost despite competition in the equipment market. Absent perfectly contingent long-term contracts, firms will balance the advantages of marginal-cost pricing to future generations of consumers against the payoff from monopoly pricing for current, locked-in equipment owners. The result holds for undifferentiated Bertrand competition, differentiated duopoly, and monopoly equipment markets. We also examine the effects of market growth and equipment durability.     

Exercising Market Power in Proprietary Aftermarkets

Over 20 recent antitrust cases have turned on whether competition in complex durable-equipment markets prevents manufacturers from exercising market power over proprietary aftermarket products and services. We show that the price in the aftermarket will exceed marginal cost despite competition in the equipment market. Absent perfectly contingent long-term contracts, firms will balance the advantages of marginal-cost pricing to future generations of consumers against the payoff from monopoly pricing for current, locked-in equipment owners. The result holds for undifferentiated Bertrand competition, differentiated duopoly, and monopoly equipment markets. We also examine the effects of market growth and equipment durability.     

Firm entry,product repositioning and welfare

We show that the entry of a second firm in a horizontally differentiated market (ala Hotelling) may harm consumers as prices increase and consumer’s surplus possibly decrease. We first derive the price and the consumer’s surplus of a monopoly which is located at the center of the market. When a second firm enters the market the first firm repositions and the two firms locate at their equilibrium points. Although competition adds to variety and increases consumer’s surplus, the post entry increase in price may outweight the gains from extra variety and make consumers worse off.     

Behavior‐ and characteristic‐based price discrimination

We develop a model of behavior‐ and characteristic‐based discriminatory pricing where consumers are heterogeneous both in tastes and in price sensitivity. Each firm is able to distinguish between the consumers that have bought from it and those that have bought from the rival. Furthermore, each firm learns the price sensitivity of their own consumers. We show that using this additional information may yield higher profits than uniform pricing provided that consumers are heterogeneous enough with respect to price sensitivity. We also discuss consumer surplus implications of such behavior‐ and characteristic‐based price discrimination, and we show that the impact of price discrimination depends on both the consumer type and the level of consumers’ heterogeneity.     

Product Differentiation by Competing Vertical Hierarchies

We revisit the choice of product differentiation in the Hotelling model, by assuming that competing firms are vertically separated, and that retailers choose products' characteristics. The “principle of differentiation” does not hold because retailers with private information about their marginal costs produce less differentiated products in order to increase their information rents. Hence, information asymmetry within vertical hierarchies may increase social welfare by inducing them to sell products that appeal to a larger number of consumers. We show that the socially optimal level of transparency between manufacturers and retailers depends on the weight assigned to consumers' surplus and trades off two effects: higher transparency reduces price distortion but induces retailers to produce excessively similar products.     

Price dispersion and optimal price categories with limited memory consumers

In this paper, we study consumers with limited memory and examine the effects of their price categorization on the pricing strategies of competing firms. The valuations of consumers are assumed to be heterogeneous. We find that it is possible to observe price dispersion even when each firm charges a single price if the consumers categorize prices non‐optimally. Moreover, we demonstrate that the likelihood of a price dispersion outcome is reduced when consumers with limited memory set up the price categories optimally. These findings suggest that the consumers' limited memory and their sub‐optimal behavior, that is, their inability to choose price categories optimally can be a reason for observed price dispersion.     

How firms compete when they set identical prices: Nonprice strategies in the Indian biscuit industry

How do firms compete when all firms in an industry set identical prices? Using Nielsen data on India's biscuit manufacturers, we document productivity-based competition on nonprice strategies under industry-wide uniform pricing. Products with one standard deviation higher quantity-based productivity contain, on average, 13% more quantity per pack for the same price. Productivity also positively correlates with promotions on pack size, availability, and variety. A higher price (per pack size) sensitivity in rural markets combined with industry-wide uniform pricing imposes a greater burden on rural consumers. Additional analyses show that firms can reduce this burden by selling different pack sizes in urban and rural areas.     

Price Competition and Advertising Signals: Signaling by Competing Senders

Can price and advertising be used by vertically differentiated duopolists to signal qualities to consumers? We show that pure price separation is impossible if the vertical differentiation is small, while adding dissipative advertising ensures the existence of separating equilibria. Two simple, but nonstandard, equilibrium refinements are introduced to deal with the multisender nature of the game, and they are shown to produce a unique separating and a unique pooling profile. Pooling results in a zero‐profit Bertrand outcome. Separation gives strictly positive duopoly profits, and dissipative advertising is used by the high‐quality firm when products are sufficiently close substitutes. Finally, compared to the complete‐information benchmark, the separating prices of both firms are distorted upwards when the degree of vertical differentiation is large, and downwards when it is small.     

Price Dispersion and Consumer Reservation Prices

We describe firm pricing when consumers follow simple reservation price rules. In stark contrast to other models in the literature, this approach yields price dispersion in pure strategies even when firms have the same marginal costs. At the equilibrium, lower price firms earn higher profits. The range of price dispersion increases with the number of firms: the highest price is the monopoly price, while the lowest price tends to marginal cost. The average transaction price remains substantially above marginal cost even with many firms. The equilibrium pricing pattern is the same when prices are chosen sequentially.     

Competition with Aftermarket Power When Consumers Are Heterogeneous

We study a model of competitive foremarkets and partly monopolized aftermarkets. We show that high aftermarket power prompts firms to engage in inefficiently aggressive below‐cost pricing in the foremarket. This inefficiency is driven by the presence of consumers with valuations below marginal cost. While for intermediate aftermarket power their presence leads to a competition‐softening effect, for high aftermarket power firms attract increasing numbers of unprofitable consumers by aggressively pricing below cost. For high aftermarket power, firms' equilibrium profits can therefore be decreasing in aftermarket power but are always higher than for low aftermarket power. If firms engage in price discrimination by bundling the foremarket and aftermarket goods or by reducing their aftermarket power, they avoid selling to unprofitable consumers but also reduce the competition‐softening effect. This decreases firms' equilibrium profits but increases consumer and social welfare.     

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.     

Loyalty Rewards Facilitate Tacit Collusion

Using a dynamic overlapping‐generations model, we show that loyalty rewards robustly facilitate tacit collusion. We compare the sustainability of tacit collusion when uniform prices are used, when loyal customers are rewarded without using commitment, and when loyalty rewards are implemented by committing to offering customers either lower fixed repeat‐purchase prices or fixed repeat‐purchase discounts. We find that, relative to uniform prices, rewarding loyalty without using commitment on the equilibrium path makes tacit collusion easier to sustain, because a deviating firm is unable to steal one period of industry profit before losing all future profits. When loyalty rewards are offered by firms committing to repeat‐purchase prices, collusion is even easier to sustain, because a deviating firm cannot renege on its discounted price for repeat‐purchase customers. When firms commit to repeat‐purchase discounts, they also commit to lowering the price for their repeat‐purchase customers if they undercut the regular price, rendering tacit collusion to be even more readily sustainable. Our results hold whether products are homogeneous or horizontally differentiated as in a Hotelling model.     

Quantity precommitment and price-matching

We study the effects of price-matching in a capacity-constrained duopoly setting. We show that no firm does worse at any pure equilibrium under price-matching relative to Bertrand, but as capacity increases, one or both firms do better relative to Bertrand. If the firms choose their capacities simultaneously before making pricing decisions, then the effect of price-matching varies with the cost of capacity. Specifically, when the cost is “high” price-matching either (i) has no effect on the market price, i.e., the market price associated with the pure SPEs is the Cournot one, or (ii) weakly decreases the market price relative to Cournot. Furthermore, when the cost is “low” price-matching leads to a set of (pure) SPE prices that includes the Cournot price in the interior. Therefore, price-matching does not necessarily benefit the firms when firms select their capacities before competing in price.     

Bundling and joint marketing by rival firms

We study joint marketing by firms who price discriminate between consumers who patronize only one firm (single purchasers) and those who purchase from both (bundle purchasers). Firms either set the price of the bundle and then compete along side the bundle; or they determine a rebate that is applied to joint purchasers and then set prices. Even though the pricing structure in the joint marketing scheme is determined noncooperatively, the commitment to the joint marketing agreement allows firms to leverage their stand‐alone prices—leading to higher profits and lower consumer surplus in either case, compared to both uniform pricing and independent price discrimination without a joint marketing agreement. Nevertheless the two schemes differ dramatically, in that rebates increase joint purchasing, whereas bundle pricing diminishes bundle purchases.     

Spatial competition under uniform delivered pricing

A Hotelling-type model of spatial competition is considered, in which two firms compete in uniform delivered prices. First, it is shown that there exists no uniform delivered price–location equilibrium when the product sold by the firms is perfectly homogeneous andwhen consumers buy from the firm quoting the lower delivered price. Second, when the product is heterogeneous and when preferences are identically, independently Weibull-distributed with standard deviation μ, we prove that there exists a single uniform delivered price–location equilibrium iff μ≧1/8 times the transportation rate times the size of the market. In equilibrium, firms are located at the center of the market and charge the same uniform delivered price, which equals their average transportation cost, plus a mark-up of 2μ. Finally, we discuss how our result extends to the case of n firms and proceed to a comparison of equilibria under uniform mill and delivered pricing.     

Exclusivity and Control

We model competition between content distributors (platforms) for content providers, and show that whether or not content is exclusive or “multihomes” depends crucially on whether or not content providers maintain control over their own pricing to consumers: if content providers sell their content outright and relinquish control, they will tend to be exclusive; on the other hand, if content providers maintain control and only “affiliate” with platforms, then multihoming is sustainable in equilibrium. We show that the outcome under affiliation depends on the tradeoff between platform rent extraction (which increases in exclusivity) and content rent extraction (which increases in multihoming), and demonstrate that the propensity for exclusivity can be increasing, decreasing, or even nonmonotonic in content quality. Finally, if a content provider internalizes the effect of its own price on platform demand, we prove that a platform that already has exclusive access to content may prefer to relinquish control over content pricing to the content provider in order to reduce price competition at the platform level.