Quality Segmentation in Spatial Markets: When Does Cannibalization Affect Product Line Design?

Abstract

Durable goods manufacturers often design product lines by segmenting their markets on quality attributes—attributes that exhibit a “more is better” property for all consumers. Since products within a product line are partial substitutes, and consumers can self-select the products they want to purchase, multiproduct firms have to carefully consider the cannibalization problem in designing their product lines. Existing research has analyzed the cannibalization problem for a monopolist who faces consumers who differ in their quality valuations. If lower-quality products are sufficiently attractive, higher-valuation consumers may find it beneficial to buy lower-quality products rather than the higher-quality products targeted to them. That is, lower-quality products can potentially cannibalize higher-quality products. The cannibalization problem forces the firm to provide only the highest-valuation segment with its preferred (efficient) quality. All other segments get qualities lower than their preferred (efficient) qualities. When the cannibalization problem is very severe, the firm may not serve some of the lowest-valuation segments. However, not much is known about how and when the cannibalization problem affects product line design in an oligopoly. Also, consumers may differ not only in their quality valuations but also in their taste preferences. The objective of this paper is to fill these gaps by examining whether the cannibalization problem affects a firm's price and quality decisions in a model with consumer differences in quality valuations, as well as in their taste preferences, in both monopoly and duopoly settings. The paper addresses questions such as the following. With both types of consumer differences, should a firm, even a monopolist, provide efficient quality only to the top segment? Are there conditions under which other segments can also get their preferred quality levels? If so, how do consumer and firm characteristics affect the likelihood of different segments getting their preferred qualities? How does competition affect the firm's choice of qualities? I develop a model in which the market is made up of two segments, with one segment valuing quality more than the other. Consumers within each segment are distributed over Hotelling's (1929) linear city. Consumers in the two segments can have different taste preferences (transportation costs). Firm locations in the two segments may also be different. The paper begins with an analysis of the monopoly case. I find that when both segments are fully covered, the standard self-selection results of the high-valuation segment getting its preferred quality and the low-valuation segment getting less than its preferred quality do hold. Interestingly, when both segments are incompletely covered, under some conditions, the monopolist's price and quality choices are not determined by the cannibalization problem. In these cases, the monopolist finds it optimal to provide each segment with its preferred quality. Thus, the equilibrium quality levels in a secon...

Competition and price discrimination in the market for mailing lists

“…This is a different effect, although we will discuss this potential endogeneity when we present our empirical results. 5 Similarly, Stole (1995), Desai (2001), and Rochet and Stole (2002) show that the quality distortion associated with price discrimination can diminish as the level of competition increases.…”

Who should practice price discrimination using rebates in an asymmetric duopoly?

“…Competitive second degree price discrimination between symmetric firms is often found in works concerned with product line design (Armstrong and Vickers, 2001;Locay and Rodriguez, 1992;SchmidtMohr and Villas Boaz, 2008;Desai, 2001;Champsaur and Rochet, 1989). The closest settings to ours were investigated in Desai (2001) and Schmidt-Mohr and Villas-Boas (2008) in the context of product line design.…”

“…The closest settings to ours were investigated in Desai (2001) and Schmidt-Mohr and Villas-Boas (2008) in the context of product line design. In these works, as in the present work, consumers are distributed on a continuum with both horizontal and vertical preferences.…”

“…The difference between these works and ours is on the focus and generality. In Desai (2001) and Schmidt-Mohr and Villas-Boas (2008) symmetry is crucial for tractability, whereas in the present work asymmetry is the focus. In the above two works, product line design allows the firms to serve segments with different quality valuations, whereas here the segments differ in their price saliency-more appropriate for coupon and rebate problems.…”

“…While this does not change the basic tradeoff between the desire for discrimination and the desire to lessen competition (see Champsaur and Rochet, 1989), it drastically changes the solution concept. Finally, whereas the focus of Schmidt-Mohr and Villas-Boas (2008) is to establish the sufficient conditions for the existence of a pure strategy Nash equilibrium outcome and in Desai (2001) to characterize the conditions under which the markets provide complete or incomplete coverage, the present work is concerned with characterizing the equilibria, primarily mixed strategy equilibria, in an asymmetric environment.…”