Influence of market-level and inter-firm differences in costs on product positioning and pricing

ABSTRACT

The objective of this article is to study the impact of differentiation and firm positioning on firm’s pricing decisions in a horizontally differentiated competitive market. We build a parsimonious game-theoretic model and analyse simultaneous entry of firms. The effect of differentiation is modelled as an additional cost incurred by both firms based on the degree of differentiation between the firms. The cost of positioning is modelled as a market level cost affecting both firms whereby firms incur a cost if they want to position themselves away from the centre of distribution of consumers. Our analysis provides some surprising results, explains some conflicting empirical observations documented in previous research and may also be useful for further empirical research in this area by providing sharper predictions about the impact of various types of costs on market outcomes. For example, we find that if the cost of positioning is sufficiently high, then a firm with lower cost of differentiation charges a higher price in equilibrium, even when no differences in exogenous costs exist. We also 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 could be a blessing in disguise.

KEYWORDS:

• Cost leadership
• pricing
• differentiation costs
• positioning costs

JEL CLASSIFICATION:

• D43
• L13

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ In a framework similar to Correia-da-Silva and Pinho (2011), Aiura and Sato (2008) consider linear positioning costs (and no cost of differentiation) and study welfare properties of equilibrium locations. Our article is also related to Matsushima (2004) who studies the (endogenous) location of suppliers and the costs of transporting inputs from these suppliers. In our framework, positioning costs can also be interpreted as cost of transporting inputs from suppliers who are located (exogenously) at the centre of distribution of consumers but we also consider cost of differentiation as an additional cost which leads to different outcomes.

² We restrict attention to 0 < F_b – F_a < , so that the cost disadvantaged firm doesn’t leave the market completely.

³ We restrict H < (G + 1) + so that each firm has positive market share in equilibrium.

⁴ We restrict our attention to G > –t, so that the total cost incurred by the firm is >0.