Endogenous product design and quality with rationally inattentive consumers

n some markets, consumers do not know the attributes of all the products that are available in the market, or the prices at which they are offered. To overcome this uncertainty, consumers may gather and process information about those attributes and prices. In this paper, we examine the consequences of consumer costs of doing so on firms product attribute and pricing decisions. To do so, we follow the rational inattention literature in assuming that, before entering the choice situation, consumers are in contact with all products, but may have an incomplete or imprecise prior idea about their attributes and prices. Further, we also assume that consumers can, at a cost, gather and process information in a non-random fashion about any (sub)set of products, with any precision about their attributes and prices. Furthermore, we assume that products are characterized by both horizontal and vertically differentiated attributes, which we address as design and quality, respectively. We find a number of interesting results. First, if the unit costs of gathering and processing information are homogeneous among consumers, firm' should differentiate their products as those costs fall, so to relax the otherwise increasing price competition. This implies that equilibrium prices may increase as these costs decrease, because product differentiation countervails the otherwise negative impact on prices. Second, if the unit costs of gathering and processing information are heterogeneous among consumers, with a sizeable proportion of "informed" consumers, firms should always seek to differentiate their products as maximum as possible, independently of the level of information costs of the "uninformed" consumers. This implies that equilibrium price levels do not increase (and, in fact, tend to decrease) as the unit costs of those consumers decrease and that "informed" consumers serve as a "market competition guardian". Finally, in all the above cases, firms do not need to differentiate themselves along all attribute dimensions. Differentiation along one attribute dimension is more than enough to relax price competition.info:eu-repo/semantics/publishedVersio

Competitive Retailer Strategies for New Market Research, Entry and Positioning Decisions

This paper investigates strategies for new market research and positioning of stores or products by competing retailers in a duopoly setting. We examine the scenario where the two retailers are considering entry into an uncertain new market that is an extension of their existing markets. The retailers must make decisions on whether or not to first conduct research about the new market\u27s location relative to their existing markets and its size before deciding on their own positioning in it. We first study a sequential-move leader–follower setup to highlight the choice of an “innovate-or-imitate” strategy. We find when the potential new market is small, neither retailer is adequately incentivized to do research to acquire information about the new market. As the size of the new market increases, the follower is induced to do such research. When the new market is very sizable, the leader conducts research and knows the new market\u27s location while the follower free-rides. We then examine a simultaneous-move setup, in which one retailer might decide against acquiring new market information even when the cost of doing so is low. We further observe that differentiation (e.g., in terms of products or store locations) is greater in the simultaneous-move setup than in the sequential setup

Price Recall, Bertrand Paradox and Price Dispersion With Elastic Demand

This paper studies the consequence of an imprecise recall of the price by the consumers in the Bertrand price competition model for a homogeneous good. It is shown that firms can exploit this weakness and charge prices above the competitive price. This markup increases for rougher recall of the price. If firms have different production costs, those with higher costs are not driven out of the market. However they choose to have a higher price in equilibrium, therefore price dispersion arises. It is shown that firms behave on average as a monopolist with stricter demand and that price dispersion increases with the price recall errors. If bigger recall errors happen, then both consumers and firms on the aggregate level are worse off, for some parameter choices. Furthermore being given the irrational choice that some consumers make, there are situations where the protection of a monopolist against entrants is a welfare maximizing policy. The introduction of more firms in the market does not have a significant impact on the prices. Even though the presented model is static, it can be interpreted as a stage game of an infinitely repeated game where a Nash Equilibrium is played in every stage. The intuition is that consumers do not actually seek information before every purchase, but have a vague idea of the price they faced in previous purchases.Behavioral Industrial Organization;Bounded Rationality;Price Recall;Price Dispersion;Bertrand Paradox

Strategic Product Design for Retail Channel Acceptance under Uncertainty and Competition

Significant recent research has focused on the marriage of consumer preferences and engineering design in order to improve profitability. However, in many markets, the profitability of new products for manufacturers is also a significant function of the retail channel structure through which the new products reach the ultimate customer. At the crux of the issue is the fact that channel dominating retailers, like Home Depot, Toys R' Us, Wal-Mart have significant power arising from their hundreds of billions of dollars of sales revenue and have the ability to unilaterally control a manufacturer's access to the customers. A product design methodology is proposed that accounts for this new and important power asymmetry. Manufacturer's product success as defined by profit is affected by pricing at the retail and wholesale levels which in turn is dependent on the channel structure, i.e., retailer monopoly or duopoly. These channel structures are explored in this dissertation under an econometric or game theoretic framework and the results are shown to have important implications for designers. Additional non-traditional considerations for engineering product design such as bundling and exclusive contracts which are typical for retail channels are also explored by integrating marketing models with a design optimization structure. Lastly, some design methods for mitigating uncertainty in the strategic landscape of retailer dominated channels are developed. The dissertation has three research thrusts. Research Thrust 1 is devoted to developing a product design optimization approach with retailer acceptance as a probabilistic constraint on candidate designs. Slotting allowances are considered in concert with engineering design as complimentary approaches to achieving access to consumer markets. The retailer's decision framework and the design optimization approach of Thrust 1 are extended in Thrust 2 to include competitive pricing responses from both competing manufacturers and channel controlling retailers. In Thrust 2 the implications for product design when manufacturers face monopolistic and duopolistic retail channels is explored as well as the design implications of an exclusive manufacturer/retailer relationship. Finally, in Thrust 3 the prior thrusts are implemented for multiple product categories and product bundles in order to consider synergy and competition amongst multiple complementary designs. Under this final Thrust 3, an approach to mitigating the risk of uncertainty in competitor design attributes is also developed

STRATEGIC PRODUCT DESIGN DECISIONS FOR UNCERTAIN, CONVERGING AND SERVICE ORIENTED MARKETS

Market driven product design decisions are receiving increasing attention in the engineering design research literature. Econometric models and marketing research techniques are being integrated into engineering design in order to assist with profit maximizing product design decisions. This stream of research is referred to as "Design for Market Systems" (DMS). The existing DMS approaches fall short when the market environment is complex. The complexity can be incurred by the uncertain action-reactions of market players which impose unexpected market responses to a new design. The complexity can originate from the emergence of a niche product which creates a new product market by integrating the features of two or more existing products categories. The complexity can also arise when the designer is challenged to handle the couplings of outsourced subsystems from suppliers and explore the integration of the product with service providers. The objective of the thesis is to overcome such limitations and facilitate design decisions by modeling and interpreting the complex market environment. The research objective is achieved by three research thrusts. Thrust 1 examines the impact of action-reactions of market players on the long and short term design decisions for single category products using an agent based simulation approach. Thrust 2 concerns the design decisions for "convergence products". A convergence product physically integrates two or more existing product categories into a common product form. Convergence products make the consumer choice behavior and profit implications of design alternatives differ significantly from the situation where only a single product market is involved. Thrust 3 explores product design decisions while considering the connection to the upstream suppliers and downstream service providers. The connection is achieved by a quantitative understanding of interoperability of physical product modules as well as between a physical product and a service provider

Asymmetric information and exchange of information about product differentiation

We introduce asymmetric information about consumers' transportation costs (i.e., the degree of product differentiation) in the model of Hotelling (1929). When the transportation costs are high, both firms have lower profits than in the case of perfect information. Contrarily, both firms may prefer the asymmetric information case if the transportation costs are low (the informed firm always prefers the informational advantage, while the uninformed firm may or may not prefer to remain uninformed). Information sharing is ex-ante advantageous for the firms, but ex-post damaging in the case of low transportation costs. If the information is not verifiable, the informed firm always tends to announce that the transportation cost is high. To induce truthful revelation: (i) the uninformed firm must pay for the informed firm to confess that the transportation costs are low; and (ii) the informed firm must make a payment (to the uninformed firm or to a third party) for the uninformed firm to believe that the transportation costs are high.Hotelling model; Horizontal differentiation; Asymmetric information; Transportation costs; Information sharing

Is Online Product Information Availability Driven by Quality or Differentiation?

We present a game theoretic model for the availability of product information in Internet markets, where buyers can search for multiple products in parallel. We use a multiple-circle variation of Salop’s “unit circle” model of product differentiation where vendors are able to differentiate their products both horizontally (taste) and vertically (quality). We explore the conditions under which vendors make horizontal and vertical product information available to potential customers in equilibrium. We demonstrate that vendors will choose not to provide their full horizontal product information, and will rather leave the buyers with some probabilistic knowledge about their exact horizontal product locations. However, the vendors will release enough horizontal product information for their products to appear distinct from those of competitors. The sellers’ incentives to disseminate vertical product information are shown to be fundamentally different: only the worst possible quality vendors will withhold information on vertical product parameters. Our results suggest an answer for the question that is the title of this paper: Is it the case that online vendors release product information primarily to advertise their product’s superiority or to make clear that their products do not have close competing substitutes? We find that for high quality products the former is more important while the latter gains significance for lower quality products. We present empirical observations of nearly 2,000 products in the PC game industry that provide evidence in favor of the model’s predictions

Essays on Firm Strategies and Market Outcomes

In the first chapter of my dissertation, Aleksandr Yankelevich and I examine the effects of price matching guarantees on duopoly markets. We find that a commitment to price-match raises prices by altering consumer search behavior in three ways. First, price-matching diminishes firms’ incentives to lower prices to attract consumers who have no search costs. Second, for consumers with positive search costs, price-matching lowers the marginal benefit of search, inducing them to accept higher prices. Finally, price-matching can lead to asymmetric equilibria where one firm runs fewer sales and both firms tend to offer smaller discounts than in a symmetric equilibrium. These price increases grow with the proportion of consumers who invoke price-matching guarantees and also in the level of equilibrium asymmetry. The second chapter studies the effect of the complexity of consumers’ preferences over a product on that product’s market structure. I relate complexity of preferences to the number of dimensions of a Lancasterian characteristic space. Using a novel higher dimensional Hotelling model, I find that a fixed number of firms are likely to be better off competing over products with more complex preferences. Although firms face more intense competition in higher dimensional markets, the greater product differentiation afforded to them allows them to charge higher prices and earn higher profits. This result provides a clear theoretical foundation for the observation that goods associated with more complex preferences typically display a greater variety of products sold. Additionally, I show that the behavior of more than two firms competing in more than one dimension differs wildly from that of firms typically studied in models of spatial competition. The final chapter will examine firms\u27 motives for implementing grandfather clauses that allow certain consumers to continue to access a service at a favorable, but no longer available price. Grandfather clauses permit firms to price discriminate between early adopters and new consumers in exchange for forfeiting the right to optimally set prices for early adopters. They may be used to thwart competition following a structural change, to respond to cost shocks, or to retain customers who consume another good from a multiproduct firm. We analyze under what conditions firms might choose to offer grandfather clauses and what effects they have on welfare