Essays on product differentiation and pricing using the Hotelling framework
The objective of this dissertation is to understand optimal firm strategies (positioning and pricing strategies) using a parsimonious model under three different conditions. In Essay 1, I study competitive positioning and pricing strategies in markets where consumers seek variety. Variety seeking is modeled as a decrease in the willingness-to-pay for the product purchased on the previous purchase occasion. Using a three stage Hotelling type model, I show that the presence of variety seeking consumers reduces product differentiation offered in equilibrium. I find that firms charge higher prices in Period 1 and lower prices in Period 2. The lower prices in Period 2 represent the depth of promotion that firms need to offer in order to prevent the variety seeking consumers from switching. I also show that the presence of variety seeking consumers leads to lower firm profits and a higher consumer surplus. In Essay 2, I study the impact of costs associated with differentiation and cost of positioning on firm's positioning and pricing decisions in a horizontally differentiated market. I analyze both sequential and simultaneous entry cases. I find that under some circumstances the cost disadvantaged firm can enjoy higher price-cost margins compared to the cost leader thereby suggesting that higher costs are a blessing in disguise. I also show analytically that a firm incurring the cost of differentiation may still charge a lower price than the cost leader if the cost of differentiation is not that high and vice versa. In my third essay, I focus on positioning and pricing strategies in a network externality environment. I model the strength of network externality effect on consumer willingness to pay to be higher for consumers who are located closer to the firm. Considering the simultaneous entry of firms, I find that firms' differentiate more in equilibrium in such markets compared to the benchmark case where network externalities don't exist.
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