final product line

8/7/2019 final product line

http://slidepdf.com/reader/full/final-product-line 1/29

Product Line Pricing

MMA A NN A A GGEER R II A A LL EECCOONN OOMMII CCSS

REPORT ON:

PRODUCT LINE PRICING




PREPAIRED BY

Name Course Roll No

MADHUSUDAN B. HANWAT MMM M091056

VIDULA PARADKAR MHRDM H091030

SUMIT KADAM MFM F091019

VAM VARM MMM M091043

SATYAVAN RAUNDHAL MMM M091051

BABURAO BADHE MMM M091050KOMAL S. KATKADE MHRDM H091009

MANGESH J. PATIL MHRDM H091014

MANOJ JADHAV MFM F091015

SUJEET KOTHAWADE MFM F091023

KANAIYA BAROT MMM M091006

Prepared for

MS.Joshi

INSTITUTE MANAGEMENT & COMPUTER STUDIES, THANE




A PROJECT REPORT ON

(PRODUCT LINE PRICING)By

Name Course Roll No

MADHUSUDAN B. HANWAT MMM M091056

VIDULA PARADKAR MHRDM H091030

SUMIT KADAM MFM F091019

VAM VARM MMM M091043

SATYAVAN RAUNDHAL MMM M091051

BABURAO BADHE MMM M091050

KOMAL S. KATKADE MHRDM H091009

MANGESH J. PATIL MHRDM H091014

MANOJ JADHAV MFM F091015

SUJEET KOTHAWADE MFM F091023

KANAIYA BAROT MMM M091006

Approved by

Ms. Joshi, Professor

A Project Report submitted in partial fulfillment Of the requirements of

THE MMS PROGRAM (CLASS 2010)

INSTITUTE OF MANAGEMENT AND COMPUTER STUDIES




ACKNOWLEDGEMENT

We take this opportunity of submitting this dissertation to express our deepgratitude to all those who offered their valuable help and time without which thisproject would not have progressed. The success of starting this project lies solely

on the kind assistance and encouragement of all those people.

We are greatly indebted to our guide Prof. Ms. Joshi for giving us the opportunity

to work on this project in spite our inexperience and providing us with valuableinsights and much needed encouragement from time to time.




CERTIFICATE

This is to certify that the said project is undertaken under my guidance as a part

of curriculum activity and a part of the subject. Further to certify that the saidproject is completed and submitted to me in prescribed time limit and project isproperly handled by the team

_________________ ____________________

Sign. Of Guide IMCOST, Principle(M.S. Joshi)

Date :- 08.03.2010

Place :- Thane




Table of Contents

1. INTRODUCTION ................................................................................7

2. PRODUCT -LINE PRICING..................................................................9

3. PRODUCT L INE P RICING STRATEGY ..............................................10

4. ALTERN ATIVE POLI CIES OF P RICE RELATIONSHIP .......................12

5. WHEN TO USE PRODUCT LIN E PR ICING STRATEGY ......................13

6. DEMAND R ELATIONSHIP IN PRODUCT LINE .................................16 7. RETAIL PRODUCT-LINE PRICING STRATEGY WHEN COSTS AND

PRODUCTS CHANGE ..............................................................................17

8. CASE STUDY....................................................................................20

9. THE MODEL .....................................................................................22

10. DISCR IMIN ATION I N THE EUROPEAN CAR MARKET...................26

11. CONCLUSIONS .............................................................................29




1. INTRODUCTION

Product l in ing is the market ing strategy of offer ing for sa le

several related products.Unlike product bundling, where severalproducts are combined into one, lining involves offering several

related products individually. A line can comprise related productsof various sizes, types, colors, qualities, or prices. Line depth ref ersto the number of product variants in a line. Line consistency refers

to how closely related the products that make up the line are. Linevulnerability refers to the percentage of sales or profits that arederived from only a few products in the line.

The number of different product lines sold by a company is referredto as width of product mix. The total number of products sold in all

l ines is referred to as length of product mix. If a line of products is

sold with the same brand name, this is referred to as familybranding. When you add a new product to a line, it is referred to as

a line extension. When you add a line extension that is of betterquality than the other products in the line, this is referred to astrading up or brand leveraging. When you add a line extension that

is of lower quality than the other products of the line, this isreferred to as trading down. When you trade down, you will l ikelyreduce your brand equity. You are gaining short-term sales at theexpense of long term sales.

Image anchors are highly promoted products within a line that

define the image of the whole line. Image anchors are usually fromthe higher end of the line's range. When you add a new product

within the current range of an incomplete line, this is referred to asline filling.

Price lining is the use of a limited number of prices for all yourproduct offerings. This is a tradition started in the old five and dimestores in which everything cost either 5 or 10 cents. Its underlying

rationale is that these amounts are seen as suitable price points fora whole range of products by prospective customers. It has theadvantage of ease of administering, but the disadvantage of inflexibility, particularly i n times of inflation or unstable prices.




There are many important decisions about product and service

development and marketing. In the process of product developmentand marketing we should focus on strategic decisions about productattributes, product branding, product packaging, product labeling

and product support services. But product strategy also calls forbuilding a product line.




2. PRODUCT-LINE PRICING

Product line pricing is also becoming an increasingly common feature of many

markets, particularly manufactured products where there are many closely con-nected complementary products that consumers may be enticed to buy. It isfrequently observed that a producer may manufacture many related products.

They may choose to charge one low price for the core product (accepting alower mark-up or profit on cost) as a means of attracting customers to the com-ponents / accessories that have a much higher mark-up or profit margin.

Establishing a single price for all products in a product line, such as having aprice of $55 for the high-priced line of dress shirts, $45 for the medium-pricedline, and $35 for the lower priced line. Product line pricing factors in the impact

of a product's price on demand for another product offered by that marketer. For

example, if McDonald's offered a $12 sandwich, it would be far out of theprice/value range established by other sandwiches in McDonald's product line

and demand would be minimal. The price of a complementary product such assoftware can directly impact demand for the hardware. The higher the price of the software, the lower the demand for the hardware. McDonald's could afford to

offer a beverage at cost if the incremental sandwich sales revenue gained as aresult outweighed the lost beverage revenue. The price of a product such as acompact car can impact demand for another compact car model that would serve

as a substitute. The higher the price of one car, the greater the demand for theother. Variations in manufacturing costs across products are also a factor inProduct line pricing.




3. PR ODUCT LINE PR ICING STRATEGY

You can only use a product l ine pr ic ing strategy i f you have awhole product l ine or i f you are in the proce ss of bui ld ing a whole

product l ine (more than one product, and usual ly more than sev-

eral products). This statement seems self-evident but remember

products are not usual ly brought out in a fu l l l ine; they are intro-duced one at a t ime.

So, to use a product l ine pr ic ing strategy you wi l l need to keep

track o f each product's l i fe cycl e stage, how inter -dependent the

products are, when you estimate a product wil l leave the l ine,

when a new product is scheduled to enter the l ine, and how theproducts in the l ine complement each other. Al l of these productl ine e lements wi l l affect your product l ine pr ic ing strategy.

One way of looking at pr ic ing for a product l ine is to consider

pr ic ing and prof i tabi l i ty of the whole l ine, not only individual

products of the l ine. In th is type of pr ice analys is , you might have

some products that lose money but they help pul l in buyers for

those products that make money (preferably that make a lot of

money). Other prod ucts in the l ine might just break-even but they

contr ibute to the fu l lness of the l i ne and help support the money-making products.

The other way to look at pro duct l ine pr ic ing is to analyze the im-

portance of one or more products to the whole l ine. For example,

for a car dealership, the car model is the product, and the acces-

sor ies, extended warrant ies, service package, color, sunroof and

other opt ions are the rest of the l ine i tems. Those l ine i tems

would be rather meaningless, for the most part , without the caras the pr imary product.




Product l ine pr ic ing strategies can be further compl icated by com-

pet it ive act iv ity by product, not exclus ively by l ine. If you have

f ive compet itors for one of your products in the l ine, and then

only two compet itors for the other products in the l ine, you might

use a dif ferent pr ice strateg y for the product with l ots of compet i-

t ion, than the other l ine products.

Some more specif ic product l ine pr ice strategies are opt ional-

feature pricing (such as in the car example above); ancil lary

product pr ic ing (such as a digita l camera that is packaged with a

lens, a case, a battery charger, a memory card, etc.); two-part

pricing uch as a museum that charges for general entrance and

then adds an addit ional charge for entrance to a special exhibit);

product bundl ing pr ic ing ( in the above car example, i f you buy the

car and the accessor ies or one of the other opt ions at the same

time you wi l l receive a better pr ice than i f you buy some of theaccessor ies separately or later).

Make sure to bui ld a strong promotional program for product l ine

pr ic ing; buyers need to c lear ly understand what they are buying,

what the differences are with in the l ine (especia l ly i f there is not

clear dif ferent iat ion), and the benef its of buyi ng bundles, opt ional

features or other l ine accessor ies at the same t ime as the pr imary

product. Your buyers wi l l a lso need to understand the pr ic ing and

value differences between the products and with in the l ine.




4. Alternati ve policies of price relationship

A logical approach to product l ine pr ic i ng is to start with a picture

of the a lteranat ive kinds of pol icy regarding the re lat ionships

among pr ices of members of product l ine. This approach assumes

that i t is des irable to have some kind of underly ing system of re-lat ionship of product pr ices which is debatable. But before adopt-

ing a phi losophy of chaos i t is wel l to examine systematic pat-terns, several of which are sketched below.

1] Pr ices that are proport ional to fu l l cost, i .e. , that produce thesame percentage net prof i t margin for a l l prod uct.

2] Pr ices that are proport ional to incremental cost, i .e. , that pro-

duces the same percentage contr ibut ion- margin over incr emental

cost for a l l products.

3] Pr ices with prof i t margins that are proport ional to convers ioncost, i.e., that take no account of purchase materials cost.

4] Prices that produce contribution margins that depend upon theelast ic i ty of demand of dif ferent market segment.

5] Pr ices that are systematica l ly re lated to the stage of market

and compet it ive development of individual members of the prod-uct l ine.




5. WHEN TO USE PRODUCT LINE PRICING STRATEGY

Let me state the obvious: yo u can only use a product l ine pr ic ing

strategy i f you have a whole product l ine or i f you are in the

process of bui ld ing a whole product l ine (more than one product,

and usual ly more than several products). This statement seemsself-evident but remember p roducts are not usual ly brought out in

a ful l l ine; they are introduced one at a t ime.


track of each product's l i fe cyc le stage, how i nter -dependent the

products are, when you est imate a product wi l l leave the l ine,

when a new product is scheduled to enter the l ine, and how the

products in the l ine complement each other. Al l of these product

l ine e lements wi l l affect your product l ine pr ic ing strategy.




some products that lose money but they help pul l in buyers for

those products that make money (preferably that make a lot of


contr ibute to the fu l lness of the l i ne and help support the money-

making products.

The other way to look at prod uct l ine pr ic ing is to analyze the im-portance of one or more products to the whole l ine. For example,



other opt ions are the rest of the l ine i tems. Those l ine i tems

would be rather meaningless, for the most part , without the car

as the pr imary product.

Product l ine pr ic ing strategies can be further compl icated by com-

pet it ive act iv ity by product, not exclus ively by l ine. If you have

f ive compet itors for one of your products in the l ine, and thenonly two compet itors for the other products in the l ine, you

might use a dif ferent pr ice strategy for the product with lots of

competit ion, than the other l ine products.




Some more specif ic product l ine pr ice strategies are opt ional-

feature pricing (such as in the car example above); ancil lary

product pr ic ing (such as a digita l camera that is packaged with a

lens, a case, a battery charger, a memory card, etc.); two-part

pricing (such as a museum that charges for general entrance and

then adds an addit ional charge for entrance to a special exhibit);product bundl ing pr ic ing ( in the above car example, i f you buy the

car and the accessor ies or one of the other opt ions at the same

time you wi l l receive a better pr ice than i f you buy some of the

accessor ies separately or later).

Make sure to bui ld a strong promotional program for product l ine

pr ic ing; buyers need to c lear ly understand what they are buying,

what the differences are with in the l ine (especia l ly i f there is not

clear dif ferent iat ion), and the benef its of buying bundles, opt ional

features or other l ine accessor ies at the same t ime as the pr imaryproduct. Your buyers wi l l a lso need to understand the pr ic ing and

value differences between the products and with in the l ine.

Let me state the obvious: you can only use a product l ine pr ic ing

strategy i f you have a whole product l ine or i f you are in the

process of bui ld ing a whole product l ine (more than one product,

and usual ly more than several products). This statement seems

self-evident but remember products are not usual ly brought out in

a ful l l ine; they are introduced one at a t ime.


track of each product's l i fe cyc le stage, how i nter -dependent the

products are, when you estimate a product wil l leave the l ine,

when a new product is scheduled to enter the l ine, and how the

products in the l ine complement each other. Al l of these product

l ine e lements wi l l affect your product l ine pr ic ing strategy.







some products that lose money but they help pul l in buyers forth os e products that make money (preferably that make a lot of


contr ibute to the fu l lness of the l i ne and help support the money-

making products.

The other way to look at product l ine pr i c ing is to analyze the im-

portance of one or more products to the whole l ine. For example,



other opt ions are the rest of the l ine i tems. Those l ine i temswould be rather meaningless, for the most part , without the car

as the pr imary product.




6. DEMAND RELATIONSHIP IN PRODUCT LINE

Tw o demand character ist ic pecul iar to mult ip le- product l ines ares ignif icant for pr ic i ng p urpose. The f irst is the interdependent of

the demand for var ious product of member’s l ine. Interdepend-

ence takes many form. Products may be substitutes for each

other, e.g., dif ferent models of radios or grades of t i res. They

may be complementary, e.g., tabulators and punched cards. They

may be complementary in the more remote and subt le sense of

augment ing one another ’s e.g., in enhancing the reputat ion of the

f i rm.

Interdependence also has a t ime dimension. The sales of oneproduct today may affect the sales of another product tomorrow.

Str ik ing examples are introductory models, such tr ia l subscr ipt ions

and chi ldren’s edit ions of magazines, diminut ive sport ing equip-

ments. But this t ime aspect extends into any product group in

which the sales of one product tends to t ie the customer to future

purchase of another product as exemplif ied by the slow-speed

phonographs and their records.

A second demand character ist ic in mult ip le-product l ines is their

importance as instruments for market segmentations and pricediscr iminat ions. They provide opportunit ies for breaking the mar-

ket into smal ler sector that dif fer in pr ice e last ic i ty and hence can

prof itably be charged different pr ices. Product des ign and pr ic ing

and major methods for achieving segmentat ion. Not only can mar-

ket segmentat ion increase prof i ts by sett ing pr ices that take ad-

vantage of the different e last ic i ty of demand in each sector; i t can

also increase tota l sa les by penetrat ing mass markets at pr ices

that cover incremental costs and contribute a l itt le to over -head.




7. Retail Product-Line Pricing Strategy When Costs and ProductsChange

Technological advances and other factors are rapidly changing the

nature of products and cost structures. Such factors can impact

product ingredients and cost components, having a sudden dra-mat ic impact on the wholesale and reta i l pr ices of many var iants

with in product l ines such as computers, pr inters, digi ta l cameras,

cel lu lar phones and kitchen electr ics. Decreases in computer chip

pr ices, for example, affect the pr ices of many products from cel lu-

lar phones to a larm clocks; increases in wages impact most ser-

vices from health care to banking; and, oi l pr ice shocks dramati-

cal ly impact many products from automobi les to home insulat ion.

These rapid changes can also lead to abrupt addit ions or delet ions

from a product l ine.

However, cost changes can have a disproport ionate impact on

only one end of the l ine (e.g., h igher or lower qual i ty var iants)

because quality differences are often caused by differences in

components or ingredients. For example, increases in the pr ice of

diamonds might have a disproport ionate impact on the higher

qual i ty var iants of the jewelry l ines (e.g., watches, earr ings,

necklaces, and bracelets) because, for such variants, a greater

percentage of the cost comes from diamonds. Lower qual i ty jew-

elry var iants may contain few or no diamonds. S imi lar ly, de-

creases in the pr ices of n ickel cadmium batter ies may have moreimpact on lower qual i ty e lectronic devices (e.g., camcorders, CD

players, cordless te lephones, and home laptop computers) be-

cause higher qual i ty devices use other types of batter ies (e.g.,

manganese l i th ium). In yet other instances, cost changes are fe lt

proport ional ly throughout the l ine. For instance, increases in a l-

cohol taxes can have a proport ional impact on the cost of l iquor

products. The cost o f each wine bott le , for example, may increase

by 10 percent.

One strategy f or dealing with a co st change is to implement a co r-respondi ng pric e change; for exa mple, who lesale cost inc r ements

(decrements) result in h igher ( lower) reta i l pr ices. Such strate-

gies, however, may not consider the interact ions among the var i-

ants of a reta i l product l ine. These interact ions imply that in addi-

t ion to consider ing the impact of a var iant 's pr ice on that var iant 's

prof i t , i t is v ita l for the reta i ler to consider the impact of that

pr ice on the prof i ts of other var iants in the l ine.




Recent research suggests that these product l i ne interact ions may

be more complex than previously bel ieved. In many cases, prod-

ucts show a form of asymmetr ic demand relat ionship. Although

lower qual i ty brands are vulnerable to h igher qual i ty brand's pr ice

reduct ions, h igh-qual i ty brands did not show this vulnerabi l i ty.Research shows that many more consumers are incl ined to switch

up to h igher qual i ty brands than switch down to lower qual i ty

brands. Asymmetr ic l ine compet it ion is now documented in both

in-store exper iments and household- level purchasing panel-data.

Whether product var iants in a l ine exhibit asymmetr ic dem and re-

lat ionships or not, reta i lers must know how to adjust their pr ices

in response to var ious types of cost shocks. Those adjustments

must consider a l l product l ine interact ions whether they are sym-

metr ic or not. Our paper answers three key quest ions necessaryfor a rapid response. First , when the costs of specif ic product

components or ingredients change, how should reta i lers re-adjust

the pr ices of the affected product l ines? Second, what wi l l be the

impact on prof i t margins, the range of pr ices in the l ine and the

average pr ice in the l ine? Final ly, i f a product is removed, perhaps

suddenly, from the l ine, how should the reta i ler adjust the other

pr ices in the l ine?

We answer each of these three quest ions. The answers depend on

the nature of the demand relat ionships between the var iants inthe l ine. For example, consider a s imple product l ine with two

var iants. We f ind that when demand funct ions are l inear and

products display a symmetric demand relationship (i.e., changes

in two var iant 's pr ices have the same impact on each other 's de-

mand), then changes in the cost of one var iant has no impact on

the opt imal pr ice of the other var iant. However, when the demand

funct ion for a product l ine is l inear and an asymmetr ic re lat ion-

ship ex ists, there i s an inver se relat io nship betw een the cost o f

the lower qual i ty var iant and the opt imal pr ice of the higher

qual i ty var iant.

In general, when the cost of a var iant ref lects i ts qual i ty, there

are more than two var iants in the l ine and the l ine displays

asymmetr ic demand relat ionships, we f ind the fol lowing impl ica-

t ions to be true.




? When a var iant 's cost decreases, the pr ices of a l l lower-

qual i ty var iants should be decreased.

? When a var iant 's cost decreases, the prof i t margins for low-

er-qual i ty var iants should be d ecreased.

? When a var iant 's cost decreases, the pr ices of a l l h igher-

qual i ty var iants should be increased.? When a var iant 's cost decreases, the prof i t margins for

higher -qual i ty var iants should be increased.

? When the cost of my var iant (except the highest-qual i ty va-

r iant) increases, the range of pr ices in the l ine should

decrease.

? When removing a var iant from the l ine, the lower qual i ty

var iant pr ices should be increased.

? When removing a variant from the l ine, the higher quality

var iant pr ices should be decreased.

? When removing a var iant from the l ine, the range of pr icesin the l ine should be decreased.

Beyond the impl icat ions for pr ic ing strategies, these f indings

should impact other activit ies such as promotions and sell ing ef-

forts because reta i lers often a l locate more sel l ing efforts to var i-

ants with increased margins. As the l i terature suggests margins

and pr ice ranges impact a var iety of market ing deci s ions including

the al locat ion of market ing effort . Hence, by prescr ibing how

margins should change, our analys is a lso prescr ibes how reta i lers

should real locate effort . Therefore, when decl in ing costs have adisproport ionate impact on low-qual i ty products, reta i ler promo-

tions should emphasize the entire l ine. However, when those cost

decl ines have a disproport ionate impact on the high-qual i ty prod-

ucts, reta i ler promotions should shift emphasis to only the high-qual i ty products.




8. CASE STUDY

Most consumer product markets are character ized by several f i rms

offer ing product l ines that c losely match those of their compet i-

tors. The var ious companies are dif ferent iated not so much by thetype of product, but by other factors such as styl ing, warrant ies,reputat ions for re l i abi l i ty, brandname. Most car manufacturers, forexample, tend to offer the same range of cars in terms of power,s ize, engine capacity, speed, etc. The way they vary is to have astyl ing that is unique to their whole product l ine (and to their

brandname), thus a l lowing economies of scope in advert is ing, ser-vic ing, etc. Firms seem to work very hard to produce a look thatis unique, but not uniformly desired by a l l consumers (hor izontaldifferenti at ion), while at the same time they offer products whichcan vary considerably in qual i ty (vert ica l dif ferent iat ion).

This suggests that f i rms make an essent ia l ly two-dimensionalproduct l ine decis ion. The f irst is the choice of a styl ing, or com-pany pract ice, that dif ferent iates a l l of their products in somecommon way from those of their compet itors. In the secondstage, each company makes a product line decis ion whic h includes

the range of products they offer, and the corresponding priceschedule. In many markets, f i rms change their style very seldomand we therefore focus our analys is on product l ine r iva lry forexogenously chosen styles. We show that f i rms create market

power for themselves by differ ent iat ing their whole product l ine tobe able to pr ice discr iminate among consumers. Therefore, prod-uct l ine r iva lry can be vi ewed as an example of ol igopol ist ic pr icediscr iminat ion.

In our model we assume that f i rms locate in a point in style

space, and produce a product l ine that var ies in qual i ty. Consum-ers diff er in thei r income an d preferen ce for sty le. In thi s fram e-work we examine two -part pr ice schedules that include a f ixed feeand a markup, and study how pr ice discr iminat ion var ies with

compet it ion and with consumers ’ preferences for style.

We prove that a non-cooperative equil ibrium exists and show that,as compet it ion increases, pr ices approach marginal cost. Eventhough the preferences we use are der ived from those of Gabsze-wicz and Thisse (1979), our model does not lead to their natural

ol igopoly result .




The empir ica l part of the paper deals with the car market in f ivecountr ies of the European Union. For obvious reasons, detai leddata on costs as wel l as( in most cases) on volumes are unavai l-

able. There now exist several papers in which authors are able toinfer cost and demand parameters (See Berry, Levinsohn and

Pakes (1995, 1998) Goldberg (1998) and Verboven (1996) forsuch examples). Since our focus was different, we did not esti-mate the structural parameters of the model, and took a shortcut

based on the theoretical model, where we derive our results byassuming that the equil ibrium price-quality schedules are two-parttar i f fs , whose coeff ic ients are parametr ized with respect to thedegree of compet it ion. Here, we direct ly est imate these pr iceschedules, and f ind evidence that European producers use product

l ines to price discriminate.

Before turning to the detai ls of the model, let us note that, as

Brander and Eaton (1984) have pointed out in their study of prod-uct l ine r iva lry, there is re lat ively l i t t le work on the subject. Their

paper centers around the issue of entry deterrence and the choiceof scope and has l i t t le to say about pr ice discr iminat ion. The ear-l ier l i terature on product dif ferent iat ion, has gener al ly assumedthat each f irm produces a s ingle qual i ty product. More recent ly,Champsaur and Rochet (1985, 1989) addressed the question of

mult iprod-uct ol igopol ists; however the absence of hor izontal dif-ferent iat ion in their model results in each qual i ty being sold by atmost one f irm. Economides (1986) and Neven and Thisse (1990)study a model in which var iety ( i .e. , hor izontal dif ferent iat ion)and qual i ty choice ( i .e. , vert ica l dif ferent iat ion) of a s ingle prod-

uct are endogenous; however, they do not examine the case of product l ine competit ion. Gilbert and Matutes (1993) focus on theissue of commitment in determining the scope of the f irms’ pr icel ine offer ings in a model with a discrete product space. Rochetand Stole (1999) provide an extensive theoret ica l framework to

address the issue of nonl inear pr ic ing in a mult id imensional set-t ing.

They show, in part icu lar, that an eff ic ient qual i ty a l locat ion with

cost-plus-fee pr ic ing, examined in th is paper, emerges as an equi-l ibrium outcome.

The paper is organized as fol lows. In Sect ion 2 we out l ine thetheoret ica l model and state our existence and comparat ive stat icsresults, for which proofs are given in the Appendix. Sect ion 3

deals with our empir ica l results. Sect ion 4 is devoted to conclud-ing comments.




9. The model

There is a market with dif ferent iated products and there are n

f i rms, indexed by In contrast to mo st of themodels of spatial competit ion, that typical ly deal with one dimen-

sional choice spaces, we assume that f irms compete with theirproduct l ines. That is , there is an observable character ist ic whichis common to a l l products of a given f irm. In the case of the carmarket th is might be a f i rm’s dist inct ive styl ing (th ink, for exam-ple, of Mercedes-Benz or BMW who have cars with a dist inctive

“ look”) .

It wil l be assumed that the fi rms loc ate symmetri cal ly o n the ci r-c le at locat ions (see Sa lop (1979), Novshek (1980),

Horstmann and Sl iv insky (1985)). The circumference L of the c ir-cle wil l provide a measure of p otential di versity. While many co n-sumers may wish to buy a pro duct of given styl e, they wi l l in g en-eral also wish to choose among different qualit ies. Firms thereforeoffer a range of qualit ies

F i rm i s p ro duc t l ine is thus def ined b y The marginal costof producing a good of qual i ty q is the same for a l l f i rms andtakes the form c i(q) = cq.

There is a cont inuum of consumers parameter ized by their most

preferred style and income. The space of consumers is givenby where M = [m L , m H] and m L (m H) denotes the lower(upper) bound of consumers ’ income. It is furthermore assumedthat consumers are uniformly distr ibuted over Y and, without lossof general i ty, their tota l mass is equal to one. Each consumer

purchases, at pr ice p, one unit of product of style s and qual i ty q.For any consumer the choice over tr ip lets (s,q,p) ismade according to the preferences represented by the ut i l i ty func-t ion:

(1)

Where | t — s | is the (arc) distance between two points on s.The

f irst term in (1), — | t — s | , represents the disut i l i ty of a con-sumer whose preferred style is t, but who buys a product of styles . The second term, q (m—p), represents the ut i l i ty from




consuming one unit of a good of qual i ty q, at pr ice p. This is es-

sent ia l ly the funct ional form used by Gabszewicz and Thisse(1979) and Shaked and Sutton (1982), which guarantees that atgiven pri ce, co nsumers with hi gher in comes put more wei ght on

quality.S ince f irms are not able to observe the character ist ics of indi-vidual consumers and charge a tai lor-made price for each of them,

they choose pr ice as a f unct ion of qua l i ty a lone. For reasons of technical tractabi l i ty and potent ia l empir ica l appl icat ions, we as-sume that pr ice is an aff ine funct ion of qual i ty. The f irms’ pr iceschedules wi l l therefore be restr icted to two-part tar i f fs . Thus, atypical strategy of f i rm i i s which y ie lds

a pr ice P i(q ) = a i + b iq for qual i ty q . When the marginal costfor producing qual i ty q , f i rm i wil l d iscr iminate among indi vidualswith dif ferent tastes for qual i ty. Customers of f i rm i wil l buy the

good of qual i ty q yie lding the highest ut i l i ty, given b y:

(2)

Note that the qual i ty of the good chosen by an individual d ependsonly on his income. Therefore, a consumer with income m willconsume a good of qual i ty q i(m ) and pay a price P i(m ) where:

(3)

and

(4)

We furthermore assume that for each and each ,

q i(m )

i s an i nt er io r solut ion, i .e ., f or a ll and

(5)

Equat ion (5) impl ies that the pr ice schedules sat isfy a non-bunching property: i f consumers with dif ferent incomes decide topurchase a product from the same f irm, they wi l l choose differ entqual i t ies of the good. This non-bunching property guarantees

that q i(m) is a s tr ict ly increas ing funct ion of income, so that ar ich consumer wi l l purchase a good of h igher qual i ty than a poor




one. We next assume that there exists a posit ive sat isfying thefol lowing inequal i t ies:

(6)

This assumption implies that marginal cost pricing is itself a non-bunching strat-egy and sets upper and lower bounds of the possible range of incomes andqualities.

The funct ions V (· , ·), def ined by (2), enable us to der ive, for

each f irm a market area I i( ·), given by:

(7)

where x = (x 1, . . . , xn ). In general, th is results in market areas

over lapping at the boundaries. However, these intersect ions typi-cal ly consist of sets of agents with measure zero and therefore do

not affect the def in it ion of prof i ts . The prof i t of f i rm i is:

(8)

We now consider a non-cooperative game in which firm i ’s strat-

egy i s x i = ( a i, b i) and its payoff is given by (8). The parameter a i represents what is usual ly cal led a f ixed fee, whereas the differ-ence b i - c is a markup . (See Gilbert and Matutes (1993), Arm-strong and Vickers (1997), Stole and Rochet (1999).)

S ince f irms are ident ica l we consider only symmetr ic Nash equ i-l ibr ia and drop the f irm index i in what fol lows. Note that theequi l ibr ium outcomes depend on n, L and the width of the qualityand income ranges; however, L and n affect equil ibria only via theterm L/ n, which is the width of the market areas I i(x ) at a sym-

metr ic equi l ibr ium. Clear ly, when L i s f ixed, the number of f i rms nrepresents the level of co mpet it ion: as n tends to inf in ity themarket approaches perfect compet it ion.




Our f i rst result shows that when the range of incomes (repre-

sented by the rat io of the h ighest to the lowest in-

come and the number of f irms are large, then a uniqueNash equi l ibr ium wi l l exist . Formal ly ,

P roposi t ion 1 : There a re and such that for a l lthere exists a unique symmetric Nash equil ibrium.

Since we keep the bounds on consumers ’ incomes f ixed, weshal l denote the f irms’ equi l ibr ium strategies by and theequi l ibr ium pr ice

s chedules by Using (3) and (4) , t hi s y i elds qua li t y and p ri cefunctions denoted

Proposit ion 2 examines the propert ies of the equi l ibr iumstrategies and pr ice funct ions.Proposit ion 2 :There exists such

that for a l l

( i i i) The f irm’s prof i t is a decreasing funct ion of i ncome m .

The assert ions of Proposit ion 2 are fa ir ly intu it ive. Assert ion (i)

shows that, as the level of compet it ion increases, equi l ibr iumprices approach marginal costs. Assert ion ( i i ) impl ies that increas-ing compet it ion generates a decl ine of the f ixed part and an in-crease of the var iable part of the equi l ibr ium two-part pr ice

schedule. Assert ion (i i i ) can be expla ined by the fact that the

markup decl ines with qual i ty, which i tse lf is an increasing fun ct ionof income. It is important to note, therefore, that s ince themarkup of pr ices on costs is not constant, product l ines are usedas a pr ice discr iminat ing device. This suggests the poss ibi l i ty of

infer ing the degree of compet it ion from examining the equi l ibr iumprice schedules.




10. Discrimination in the European car market

Since we shal l be discuss ing pr ice discr iminat ion in Belgium,

France, Germany, Ita ly and the United Kingdom, some commentson the f ive markets are in order.

Casual observat ion seems to lend support to the assumptionthat Belgium is the most compet it ive market. Indeed, there is noBelgian domest ic prod ucer, whi le the four other countr ies a l l haveone or several producers enjoy ing some degree of protect ion. Bel-gium is a lso widely open to Japanese imports. Final ly, producer

pr ices are s ignif icant ly lower in Belgium than in a l l other countr ies(see BEUC (1984, 1986) as wel l as Mertens and Gins-burgh (1985)and Ginsburgh and Vanhamme (1989)). These observat ions arebacked up by the fact that producers complain about Belgian priceregulat ions leading to insuff ic ient prof i ts , or even losses in some

cases. On the other end of the spectrum, the United Kingdom is

character ized by r ight-hand dr iv ing which isol ates the Br it ish mar-ket and makes it diff icult for consumers to import their car fromCont inental Europe; mo reover, a substant ia l part of “pr ivate” carsis owned by companies. France, Germany and Ita ly are endowed

with characterist ics which l ie between these two extreme cases.It should also be stressed that there exist exclusive agreements

between producers and deale rs. This may turn out to impose non-tar i f f barr iers between the var ious countr ies and, though it doesnot completely prevent arbitrage, i t makes i t rather dif f icu lt . An

individual consumer from say France, can buy his car in Belgium(differences in regulat ions tend however to make th is quite dif f i -

cu lt and t ime consuming), but dealers can hardly organize ar-bitrage on a large scale basis, though th is is s lowly changing overthe years.2As was pointed out in the introduct ion, we did not es-

t imate the structuralcoefficients of the model, but took the shortcut to estimate theequi l ibr ium pr ice-qual i ty schedules Pic (q) = a ic + b ic q ic in the var i-ous countr ies c whereproducer i is act ive and to check whether the coeff ic ients a ic and

b i c satisfyassert ion ( i i ) of Proposit ion 2, i .e. whether a i c and b i c ' < b ic »

in a

country c that is a pr ior i - see above - assumed to be less com-pet it ive than country c". The un ique qua l i ty q considered in thetheoret ica l model wi l l b e replaced by a vector of character ist ics z.The characterist ics used are engine capacity, speed and length -




which are cont inuous var iables - and a dummy var iable whichrepresents the type of fuel used, diesel or gasoline.

For every producer i sel l ing in country c, the fol lowing regres-

sion is computed:

Each regress ion i c is computed by pool ing observ at ions belong-ing to three years (1988, 1989 and 1990). The var iables are as

fol lows: p i cj t i s the pr ice of make j so ld in year t ; y l is a dummyvariable which takes the value one i f observat ion ( ic , j t ) corre-sponds to year l = t and i s t he val ue o f t he kth character ist ic. The a ’ s and ß ’s are regress ion coeff ic ients - the in-tercepts a and the slopes b of the theoretical model. Note that

the dependent var iable in each regress ion is the logar ithm of the

pr ice, and not the pr ice i tse lf ; th is is done to reduce any poss ibleheteroskedast ic i ty. The theoret ica l model of Sect ion 2, is l inear,but nothing there prevents to rescale dif ferent ly the qual i ty var i-able(s).

2 The European Court in Luxemburg had to deal with such cases, and ruledagainst dealers who were not officially selected by producers. In 1999, the Euro-pean Commission imposed a Euro 102 million fine on Volkswagen who was for-

bidding Italian dealers to sell cars to Austrian and German customers, sinceprices in Austria and Germany were much higher than in Italy.




We ran 117 such individual regress ions,3 which makes i t impossi-ble to give the detai led results. Table 1 merely reports the distr i-

but ion of the R 2s, showi ng that most adj ustements are ver y sati s-factory.

Next, we ran, for each producer i , var ious hypothesis tests on the( in)equa-l i ty of the regress ion coeff ic ients across countr ies.4 The

result ing F-tests are reported in Table 2 and show that the jointtest on equal i ty of intercepts and slopes is rejected in al l cases,with the except ion of Jaguar-Daimler. This leads us to concludethat the pr ice shedules set by producers for their product l inesare s ignif icant ly dif ferent across countr ies. The joint test on

slopes only also rejects equal i ty in most cases.

This seems to impl y that producer s use character ist ics in order to

pr ice discr iminate, but does not indicate whether assert ion (i i) of Proposit ion 2 holds. To check for th is , we have ranked countr ies

according to the values of the intercepts or of the s lopes on en-gine capacit y and speed; thes e ar e the characteri st ics that are o f-ten used to dist inguish a car in a product l ine – viz. BMW 1600,1800 or Ford GT, GTI, etc.

The results of these rankings are given in Table 3, 5 which givesthe number of t imes a country is ranked lowest, second lowest,etc. for the intercept of the regress ions as wel l as for each of thes lope coeff ic ients corresponding to character ist ics (engine capac-ity, speed). For instance, Belgium has the smal lest intercept in 8

cases (out of 20), the second smal lest in 11 cases, etc. , whi le i thas the smal lest s lope on engine capacity only once, the secondsmal lest in 3 cases, and the largest in 7 cases. We also computethe mean rank for each country. This shows that Belgium corre-sponds to the most competit ive country (lowest mean rank for in-

tercept and highest for s lopes on character ist ics), 6 while theUnited Kingdom corresponds to theleast compet it ive (h ighest mean rank for intercepts and lo west fors lopes), which is consistent with the theoret ica l impl icat ions of

the model and with the above discussion.



11. Conclusions

We have considered a model of oligopolistic competition which incorporates bothhorizontal and vertical product differentiation. Firms choose a location in style

space and select a product line of different qualities. We show that a non-cooperative equilibrium exists. Taking these two views of new product introduc-tions to their logical end suggests a possible rational for why some firms may

support research and development departments and marketing departments thatare prolific but slow. Product lines that grow slowly| but never stop to grow|overtime are most efficient at solving the time inconsistency problem.

We analyze firms’ pricing strategies by specifying a supply-side model with com-peting manufacturers who sell through a common retailer. The first decsion weinvestigate is firms’ pricing strategies across the product lines they cary. While

the price differences between product lines appear to be driven primarly by costdifferences, in several instances the evidence suggests that manufactturers areusing product lines as price discrimination tools. Second, we look at firms’ pricing

decisions across flavors within a product line. We conduct a “what-if”-type ex-periment to determine if firms’ profits would increase if they were to price flavorsindividually and conclude that this is not the case. This finding suggests that

firms’ strategy of setting equal prices for all flavors within a given product line isindeed optimal.

We also study the properties of the equilibrium style and product line seletionsand show that if the degree of competition increases, prices approach marginalcost. The model is applied to the European car market; the results support the

theoretical conclusion that producers use product lines to price discriminateacross countries.

Documents

final product line