On the Effects of Consumer Search and Firm Entry in a Multiproduct Competitive Market

Abstract

This paper studies a model in which consumers search among multiple competing firms for products that match their preferences at a reasonable price. We focus on how easier search, possibly due to the adoption of search-facilitating technologies such as the Internet, influences equilibrium prices, assortments, firm profits, and consumer welfare. Conventional wisdom suggests that easier search creates a competition-intensifying effect that puts pressure on firms to lower their prices and reduce assortments. However, in our model we demonstrate that search also exhibits a market-expansion effect that encourages firms to expand their assortment-easier search means that each firm is searched by more consumers. Because of broader assortments, consumers are more likely to find products that better match their ideal preferences, improving the efficiency of the market. In fact, we demonstrate that the market-expansion effect can even dominate the competition-intensifying effect potentially leading to higher prices, broader assortments, more profits, and expanded welfare. KeywordsInternet, price competition, assortment, product variety, long-tail phenomenon, game theory, differentiated competition Disciplines Marketing | Other Computer Sciences | Other Education AbstractIf searching for a better price becomes easier for consumers, conventional wisdom suggests that pricing pressure will increase on firms, thereby lowering prices, reducing firm profits and narrowing assortments. There is indeed evidence that recent search facilitating technologies, such as the Internet, have in some markets reduced prices. But there is also evidence that firms have been able to maintain some pricing power. Furthermore, there is evidence that the Internet has expanded variety in some markets and this broadening of the available assortment has increased consumer welfare significantly. This paper studies a model in which firms compete on price and assortment and consumers search for products that match their preferences at a reasonable price. Easier search does exhibit a competition intensifying effect in our model, and this effect puts pressure on firms to lower their prices and reduce assortments. But we also show that easier search exhibits a market expansion effect that encourages firms to expand their assortment. Due to broader assortments, consumers are more likely to find products that match their ideal preferences, improving the efficiency of the market. In fact, we demonstrate that the market expansion effect can even dominate the competition intensifying effect potentially leading to higher prices, broader assortments, more profits and expanded welfare.

Using Transaction Prices to Re-Examine Price Dispersion in Electronic Markets

“…If the second effect dominates the first, price dispersion increases. Cachon et al (2007) also show that while making searches easier intensifies competition, it also gives firms access to more consumers than previously, thereby increasing prices. They further demonstrate that the market expansion effect can dominate the competition, intensifying effect leading to higher price dispersion.…”

Drivers of Finished-Goods Inventory in the U.S. Automobile Industry

“…For example, if PS is removed from the regression, the effect of SALES increases in magnitude and becomes significant. The option effect may be small because of conflicting forces: Adding options may fragment demand and make demand more variable, which would lead to more inventory, but product differentiation offers a better match to heterogeneous customer preferences, making customers more loyal (less likely to substitute), which would lead to less inventory (see Cachon et al 2008 for a model of some of these effects). Furthermore, there is evidence in the literature that the number of options may not have a strong effect on production (Fisher and Ittner 1999).…”

Research Commentary— Long Tails vs. Superstars: The Effect of Information Technology on Product Variety and Sales Concentration Patterns

“…1 See, for example, Anderson (2004); Brynjolfsson, Hu and Smith (2003); Brynjolfsson, Hu, Simester (2007); Cachon, Terwiesch, and Xu (2008); Tucker and Zhang (2009);and Oestreich-Singer and Sundararajan (2009). 2 See, for example, Rosen (1981); Fleder and Hosanagar (2009); Noe and Parker (2005).…”