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

Abstract

Price discrimination is generally thought to improve firm profits by allowing firms to extract more consumer surplus. In competition, however, price discrimination may also be costly to the firm because restrictive incentive compatibility conditions may allow the competing firm to gain market share at the discriminating firm's expense. Therefore, with asymmetric competition, it may be the case that one firm would let the other firm assume the burden of price discrimination. We investigate optimal segmentation in a market with two asymmetric firms and two heterogeneous consumer segments that differ in the importance of price and product attributes. In particular, we investigate second-degree price discrimination under competition with explicit incentive compatibility constraints thus extending prior work in marketing and economics. Focusing on the managerial implications, we explore whether it would be profitable for either or both firms to pursue a segmentation strategy using rebates as a mechanism. We identify conditions under which one or both firms would want to pursue such segmentation. We find that segmentation lessens competition for the less price-sensitive consumer segment and that this results in higher profits to both firms. A key to understanding this result is the customer remixing that segmentation leads to. We establish the key result that if firms are asymmetric in their attractiveness to consumers, the disadvantaged firm in our model is more likely to pursue a segmentation strategy than its rival in equilibrium. We then ask whether this result obtains in practice. To this end, we explore competitive segmentation empirically and are able to verify that disadvantaged firms indeed pursue segmentation through rebates with greater likelihood.

Price Discrimination as a Marketing Strategy

“…Anderson and Dana (2009) found that rebate strategy was more likely adopted by marketing strategists of a relatively disadvantaged firm compared to an obviously advantaged competitor, and therefore it was a price discrimination tool that benefited those firms with certain market disadvantage. Dogan et al (2010) found that the more competition among firms of similar products the more beneficial is the price discrimination in the form of rebates. Consistent results found in the airline industry as far as the positive relationship between price discrimination and competition (Stavins, 2001;Borenstein & Rose, 1994).…”

Commentaries and Rejoinder to “Marketing of Vice Goods: A Strategic Analysis of the Package Size Decision” by Sanjay Jain

“…This segmentation is profitable as long as it is confined to each firm's clientele and there is no competition between firms on the small package. The relationship between segmentation and competition is complicated, as has been noted by many others: Chen and Iyer (2002), Chen et al (2001), Dogan et al (2010), Kumar and Rao (2006), Zhang (1995, 2002), and Villas-Boas (2004).…”

Add-on Pricing by Asymmetric Firms

“…The question becomes whether the superior firm or inferior firm is more likely to charge add-on prices. Because add-on prices are a form of price discrimination (Ellison 2005), applying predictions from another form of price discrimination, such as rebates, would suggest the inferior firm is more likely to price discriminate than the superior firm (Dogan et al 2010). We examine whether this finding holds true for add-on pricing.…”