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The economics of demonstrations: The effect of competition on demonstration and pricing strategies

Abstract

Demonstrations of new software products and their equivalents in the automobile industry, i.e., test-drives, are an inherent part of sales efforts. Yet the quality of standard demonstrations has been criticized as being inadequate and, in particular, too short. Heavy competition at the dealer level has been pinpointed as the main reason for short, minimal demonstrations. An analysis of business cases from two industries—automobile and software—indicates that, while competition diminishes demonstration efforts in the automobile industry, it has the opposite effect in the software industry where heavy competition induces demonstration efforts. This paper studies demonstration policies in a monopoly and a duopoly and explores the role of competition and costs of production and demonstration on demonstration strategies in these two market settings. Comparing the set of conditions between the two market settings enables us to determine under which competition will increase (decrease) demonstration intensity.

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Notes

  1. 1.

    Connelly, Mary. Test drives make gains in marketing clout. Automotive News, October 16, 2006.

  2. 2.

    According to Horizon (2004), every car buyer visits, on average, 3.1 dealers before purchasing a new car. Annual new-cars sales total around 16.8–17 million cars (Horizon 2004). The average length of a standard test drive is 10 minutes (Kamm 2005). Multiplying these three figures gives 8.73 million h of test drives.

  3. 3.

    Uniform distribution is commonly used in models with risk information and risk reduction tools (e.g., Desai and Purohit 1998; Moorthy 1988; Klemperer 1987).

  4. 4.

    The alternative is to model a dynamic learning curve; however, this would shift the focus to optimizing duration rather than concentrating on the choice of whether or not to demonstrate.

  5. 5.

    The threshold search cost for the case of P D<\( \,\frac{1}{2} \) is given by \( \frac{1}{2} + \frac{1}{2}{\left( {{P^D}} \right)^2} \), and is relevant only for C = 0.

  6. 6.

    In the automobile industry, the average advertising budget constitutes 2.5% to 3.5% of revenues. (McKee 2009).

  7. 7.

    The case of non-balanced producers is much less interesting, as differences in production cost and demonstration cost will shape demonstration policies rather than the net effect of competition.

  8. 8.

    Equilibrium in asymmetric pricing strategies is possible for demonstration costs that are high enough to compensate the producer for its lower market share yet low enough to make demonstration profitable. The requirement of high demonstration costs relative to production costs and, at the same time, low demonstration costs results in very low likelihood (1.3%) of an asymmetric pricing strategy thereby allowing us to assume symmetric pricing strategy without compromising the generality of the results.

  9. 9.

    The dichotomous effect of search cost of the first experience allows assuming that the cost of the first demonstration is zero without affecting the generality of the results. We thank the anonymous reviewer for pointing out this alternative.

  10. 10.

    Welfare analysis, which is available from the author, may provide us with a better understanding of situations wherein consumers' surplus declines (inclines) as a result of demonstration as well as scenarios that result in inclines (declines) in profits. The welfare analysis suggests that for C ≤ \( \frac{1}{2} \), if demonstrations are offered, social welfare is in most instances positive, thus by adding production cost and demonstration cost, we reverse Hahn's finding.

  11. 11.

    http://www.business-software.com/crm-evaluation/crm-demos.php

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Correspondence to Amir Heiman.

Additional information

The research benefited from a grant provided by the Davidson Center for Research in Agribusiness, The Hebrew University, Israel.

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Heiman, A. The economics of demonstrations: The effect of competition on demonstration and pricing strategies. Mark Lett 21, 351–363 (2010). https://doi.org/10.1007/s11002-009-9094-1

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Keywords

  • Demonstrations
  • Duopolistic competition
  • Non-price competition
  • Pre-purchase product trial
  • Test-drive