Price Competition in Markets with Consumer Variety Seeking

Abstract

W e investigate price competition between firms in markets characterized by consumer variety seeking.While previous research has addressed the effect of consumer inertia on prices, there exists no research on the effects of variety seeking on price competition. Our study fills this gap in the literature. Using a twoperiod duopoly framework as in Klemperer's analysis of inertial markets, we show that the noncooperative pricing equilibrium in a market with consumer variety seeking may be the same as the collusive outcome in an otherwise identical market without variety seeking. Specifically, our variety-seeking model implies tacit collusion between firms in both periods, unlike the inertia model of Klemperer that implies tacit collusion between firms only in the second period but implies fierce price competition in the first period. When consumers are assumed to have rational expectations about future prices, the implied first-period prices increase further, which is consistent with what Klemperer finds in an inertial market. To summarize, while our variety-seeking analyses support two key results (pertaining to second-period prices and rational expectations) previously derived for inertial markets by Klemperer, they depart from one key result (pertaining to first-period prices).

Positioning and Pricing in a Variety Seeking Market

“…This operationalization of variety seeking is consistent with modeling variety seeking as negative state dependence and is consistent with the definition in Givon (1984), Kahn et al (1986), Feinberg et al (1992), Kahn and Raju (1991), and Chintagunta (1998). Our model is different from Klemperer (1987) and Seetharaman and Che (2009) on two additional dimensions:…”

“…Relatively few papers have examined optimal firm strategies in the presence of variety seeking consumers (Klemperer 1987, Sarigöllü and Schmittlein 1996, Seetharaman and Che 2009). Klemperer (1987) uses switching costs to model variety.…”

“…Klemperer (1987) uses switching costs to model variety. Seetharaman and Che (2009) study variety seeking in terms of staying costs. We model variety seeking (satiation) as a relative reduction in the willingness to pay of the previously purchased brand.…”

“…Seetharaman and Che (2009) model variety seeking consumers through a change in their location in a Hotelling framework. A variety seeking consumer located at x in the first period is assumed to locate at her mirror image position (1 − x) in the second period.…”

Vertical Differentiation with Variety-Seeking Consumers

“…Another departure from previous models of competition with a consumer preference for variety (Seetharaman andChe 2009, Sajeesh andRaju 2010) is that we abstract from dynamic considerations and examine a static model in which the price of the first unit is the same as the price of the second unit. This assumption acknowledges menu costs and the fact that in the industries we consider-ski resorts, amusement parks, and restaurants-prices do not tend to vary on a consumption-experience basis within the time frames we consider, such as a weekend.…”