Hide Supremacy or Admit Inferiority—Market Entry Strategies in Response to Consumer Informational Needs

Abstract

This paper investigates information provision and pricing decisions by vertically differentiated firms sequentially entering a market where consumers face uncertainty about the quality of the new product offering as well as their own preferences or willingness to pay for quality. We find that regardless of the quality of the late entrant firm’s product, the first entrant would like to commit to and provide quality-revealing information. Surprisingly, we find that a late entrant with a superior product may choose not to inform consumers of its better quality, even if that would result in consumers perceiving its product to be of inferior quality. Instead, the high-quality late entrant will opt to educate consumers about their preference for quality. On the other hand, a late entrant offering a low-end product may wish to admit to offering an inferior product rather than allowing consumers to incorrectly assume that its product may be of higher quality. We identify the primary driving factors for these seemingly unexpected informational services decisions to be the cost of educating and helping consumers to resolve different types of uncertainties, the degree of vertical product differentiation, and the early entrant service preemption.

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Fig. 1

Notes

  1. 1.

    In 2014, Apple released 2 new models, Motorola released 11, HTC came out with 27, and Samsung pumped out a total of 56 new smartphones [1].

  2. 2.

    Other examples could include automakers’ offering of test drives or the free samples given out by food producers or software companies for consumers’ trial.

  3. 3.

    For example, Verizon would communicate to wireless consumers its faster internet connection (4G vs 3G) and more access points than its competitor, AT& T [4].

  4. 4.

    Guo and Zhao [16] study firms’ sequential quality disclosure decisions while the informational provision decision in our paper involves both quality and preference dimensions.

  5. 5.

    Similarly to Kuksov and Lin [21], in the analytical model of Gu and Xie [14], competing firms simultaneously decide on whether to facilitate fit revelation for consumers.

  6. 6.

    The quality index is a summary score of all more-is-better attributes of the product. For example, in the case of a digital camera, it can be a composite measure of resolution, optical zoom, digital zoom, etc.

  7. 7.

    We are not studying the scenario where a firm enters a market with a product of quality lower than q l as that will not be classified as a viable product option in the given product category (e.g., a cellular phone without any internet connectivity features cannot be sold as a smartphone in the market).

  8. 8.

    While the quality level of the lower-end product is assumed to be identical to the basic product offered in the market, all the results in the corresponding Section 4.3 can be generalized to the case where the low-end entrant in period two offers a product of quality q 2 moderately above q l .

  9. 9.

    Qualitative results of our model will not change if high quality products incur positive marginal costs of production as long as these are not too high. And similarly to the rationale in Kuksov and Lin [21], price can’t be used to signal quality information when high quality is more costly to produce and the firm offering this product expects positive sales. Exact calculations are available upon request.

  10. 10.

    Note that if firms at each stage decide to provide informational services that resolve consumers’ uncertainty on both dimensions, consumers will have perfect information before making any purchase decision.

  11. 11.

    Note that this form is similar to the way Kopalle and Lehmann [20] model consumers’ “will” expectation about a new entry firm’s quality based on the quality claimed by advertising and information from other sources.

  12. 12.

    Newman et al. [27] provide studies showing that firms offering new products that are environmentally beneficial need to specify the exact nature of the feature enhancement (i.e., reveal true quality). Otherwise, consumers will perceive the quality to be lower due to the focus on the environmental benefits.

  13. 13.

    We assume without loss of generality that Firm 1 does not discount the second period profit.

  14. 14.

    Recall that a consumer can learn her true preference from one firm but use this information to evaluate a different firm’s product.

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Correspondence to Amit Pazgal.

Appendix

Appendix

Proof of Lemma 1

Our model assumes that Firm 1 in the second period sticks to the same informational service decision it made in the first period. This implies that Firm 1 would enjoy the same profit in each period when there is no competitive entry (—as explained in Footnote 13, Firm 1 does not discount the second period profit). Therefore, we just need to compare a single-period profit in deriving Firm 1’s optimal service decision to prove Lemma 1.

Firm 1 has 4 options of informational service decision to maximize its monopoly profit.

When not providing any informational service, consumer utility from buying firm 1’s product is

$$ U={q}_l/2-p $$
(A1)

Everyone in the market knows the true quality of Firm 1 whiling acting like “average” customer with θ = 1/2. Firm 1 gets demand from the entire market with p = q l /2, resulting profit π NS  = q l /2,

When providing quality-revealing information (S q ), consumer utility from buying firm 1’s product is

$$ U=q/2-p $$
(A2)

Again everyone in the market knows the true quality of Firm 1 whiling acting like “average” customer with θ = 1/2. Firm 1 gets demand from the entire market with p = q/2, resulting profit π Sq  = q/2 − c q ,

When providing preference-revealing information (S θ ), consumer utility is

$$ U=\theta {q}_l-p $$
(A3)

Consumers in the market perceive Firm 1’s product quality to be q l , but now have heterogeneous willingness to pay upon receiving the preference information. Firm 1 gets demand from consumers with θ ∈ [p/q l , 1] with p = q l /2, resulting profit \( {\pi_S}_{{}_{\theta }}={q}_l/4-{c}_{\theta } \),

When providing both types of information (S ), consumer utility is

$$ U=\theta q-p $$
(A4)

Consumers in the market learn the true quality of Firm 1’s product and have heterogeneous willingness to pay upon receiving both types of information. Firm 1 gets demand from consumers with θ ∈ [p/q, 1 ] with p = q/2, resulting profit \( {\pi_S}_{{}_{q\theta }}=q/4-{c}_{q\theta } \).

Finally comparing the monopoly profits from (A1) - (A4) yields the optimal decision of informational service as reported in Lemma 1.

Proof of Proposition 1

When Firm 1 commits to quality-revealing information (S q which is optimal given c q  < Δ l /2), if Firm 2 chooses to not provide any information (NS), a randomly chosen consumer’s utility from the two firms can be written as:

$$ \begin{array}{cc}\hfill {U}_1=\frac{q}{2}-{p}_1;\hfill & \hfill {U}_2=\frac{\phi {q}_l+\left(1-\phi \right)q}{2}-{p}_2\hfill \end{array} $$
(A5)

The subscripts 1 and 2 refer to the first and second entrant firms. respectively. Equilibrium of price competition is p 1 = ϕΔ l /2, p 2 = 0. All consumers buy from Firm 1 and the resulting profits are \( {\pi_{1,S}}_{{}_q}=\phi {\varDelta}_l/2-{c}_q;\ {\pi}_{2,NS}=0 \) in the second period.

Following a similar process, we can derive the equilibrium prices and profits for the two firms in the second period if Firm 2 chooses the other three alternative informational service options. The complete results are reported in the following Table 2.

Table 2 Payoffs for Firm 1 and Firm 2 in the Second Period Given Firm 1 chose to offer quality revealing information (S q )

Under the condition specified in Equation (3), it is dominated strategy for Firm 2 to choose either NS or S upon entry in the second period, given Firm 1 chooses S q . Comparing Firm 2’s payoff between S q and S θ , we have

$$ {\pi}_{2,{S}_{\theta }}-{\pi}_{2,{S}_q}=\left(\frac{\phi q{\varDelta}_l\left(q-\phi {\varDelta}_l\right)}{{\left(3q+\phi {\varDelta}_l\right)}^2}-{c}_{\theta}\right)-\left(\frac{\varDelta_h}{2}-{c}_q\right) $$
(A6)

which is positive if \( {c}_q>{c}_{\theta }+\frac{9{q}^2{\varDelta}_h+\phi {\varDelta}_h{\varDelta}_l\left(6q+\phi {\varDelta}_l\right)-2q\phi {\varDelta}_l\left(q-\phi {\varDelta}_l\right)}{2{\left(3q+\phi {\varDelta}_l\right)}^2} \).

Lastly it can be easily shown that Firm 1 will not enjoy higher total profit over the two periods even if it chooses an informational service that is not optimal in the monopolist period. This completes the proof of Proposition 1.

Proof of Proposition 2

The proof follows the same procedure as in the proof of Proposition 1. When Firm 1 commits to quality-revealing information in the first period, the low-quality Firm 2’s optimal choice of informational service upon entering in the second period is between providing preference-revealing information (S θ ) and providing both quality and preference information (S ). Comparing Firm 2’s payoff between S θ and S , we have

$$ {\pi}_{2,{S}_{\theta }}-{\pi}_{2,{S}_{q\theta }}=\left(\frac{\phi q{\varDelta}_l\left(q-\phi {\varDelta}_l\right)}{{\left(\phi {\varDelta}_l+3q\right)}^2}-{c}_{\theta}\right)-\left(\frac{\varDelta_lq{q}_l}{{\left(4{\varDelta}_l+3{q}_l\right)}^2}-{c}_{q\theta}\right) $$
(A7)

which is positive if \( {c}_{q\theta }>{c}_{\theta }+\frac{\varDelta_lq{q}_l}{{\left(4{\varDelta}_l+3{q}_l\right)}^2}-\frac{\phi q{\varDelta}_l\left(q-\phi {\varDelta}_l\right)}{{\left(\phi {\varDelta}_l+3q\right)}^2} \).

And it can also be shown that Firm 1 will not enjoy higher total profit over the two periods even if it chooses an informational service that is not optimal in the monopolist period. This completes the proof of Proposition 2.

We omit the proof of Propositions 3 as it follows the exact same procedure as in the above proofs of Propositions 1 and 2.

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Lin, Y., Pazgal, A. Hide Supremacy or Admit Inferiority—Market Entry Strategies in Response to Consumer Informational Needs. Cust. Need. and Solut. 3, 94–103 (2016). https://doi.org/10.1007/s40547-015-0061-0

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Keywords

  • Consumer uncertainty
  • Informational service
  • Competitive strategy
  • Game theory