Differentiate and Conquer: Using Consumer Learning to Grow Out Your Niche
Type
working paper
Date Issued
2017
Author(s)
Abstract
The recommendation effect introduces a new rationale for product differentiation other than the usual motivation to reduce price competition.
We introduce consumer learning in a version of Hotelling's model (1929) of spatial competition with sequential consumer purchases and a second dimension of variation, quality, about which the consumers have differential information.
With consumer learning, firms are confronted with two offsetting effects: differentiation decreases the likelihood that a product is bought in earlier periods, but, by making inference more valuable, it also increases the likelihood that later consumers buy the differentiated good.
We show that there exists a unique equilibrium in which the second effect dominates, so that the market incumbent locates in the center of the market, while the entrant differentiates by producing an ex-ante niche product.
Due to consumer learning, uninformed consumers are unambiguously better off in the equilibrium with differentiation than in the equilibrium of minimum differentiation which occurs without consumer learning.
Informed consumers are better off in the latter equilibrium, so that the overall effect on consumer welfare depends on the parameters and we can show that in some cases transparency enhancing policies are welfare decreasing.
We introduce consumer learning in a version of Hotelling's model (1929) of spatial competition with sequential consumer purchases and a second dimension of variation, quality, about which the consumers have differential information.
With consumer learning, firms are confronted with two offsetting effects: differentiation decreases the likelihood that a product is bought in earlier periods, but, by making inference more valuable, it also increases the likelihood that later consumers buy the differentiated good.
We show that there exists a unique equilibrium in which the second effect dominates, so that the market incumbent locates in the center of the market, while the entrant differentiates by producing an ex-ante niche product.
Due to consumer learning, uninformed consumers are unambiguously better off in the equilibrium with differentiation than in the equilibrium of minimum differentiation which occurs without consumer learning.
Informed consumers are better off in the latter equilibrium, so that the overall effect on consumer welfare depends on the parameters and we can show that in some cases transparency enhancing policies are welfare decreasing.
Language
English
HSG Classification
contribution to scientific community
Subject(s)
Division(s)
Contact Email Address
maximilian.conze@unisg.ch
Eprints ID
251020