Executive Summary
In several product categories, such as eyeglasses, toys, apparel, and watches, firms offer a variety of products to satisfy diverse consumer needs. The competition among firms that offer such products often is nonlocal because consumers can purchase the products easily on the World Wide Web. Even if a sufficiently large variety of products is available, the preferred products of some consumers still may be unavailable. It is also conceivable that a consumer’s preferred products may be available but the consumer may not be informed about them. Focusing on such a market, the authors address three questions.
First, how does informative advertising influence equilibrium price? When a large number of firms compete, prices are strictly increasing with informative advertising for moderately valued products, whereas the opposite finding holds when the products are highly valued. Intuitively, if the base valuation of products is moderate, some informed consumers can purchase any product in their consideration set, whereas others may purchase only one product at best. Consequently, the price sensitivity of demand varies across consumers and becomes an important driving force for the results. Informative advertising increases the relative importance of consumers who are less sensitive to price and thereby encourages firms to charge a higher price. However, when consumer valuation is sufficiently high, all informed consumers can gain surplus by buying any product in their consideration set. Therefore, firms cut prices to attract marginal consumers.
Second, what is the effect of diversity in consumers’ tastes on equilibrium price? In markets in which consumers’ tastes are more diverse, equilibrium prices are lower if consumer valuations are moderate. This result reverses if consumer valuations are high. If the number of products available in a market remains constant but consumers’ tastes become more diverse, fewer consumers will have the opportunity to purchase the product that best matches their preferences. This scenario creates two opposing forces. On the one hand, firms must motivate consumers to purchase their less preferred products and thus compete on price. On the other hand, firms face fewer direct competitors in the market, because market coverage declines, which softens price competition. Overall, when consumer valuations are moderate, prices are lower if there is greater diversity in consumer tastes. The opposite result prevails if consumer valuations are high.
Third, how do improvements in advertising technology affect equilibrium price? When consumer valuations are moderate, improvements in advertising technology lower prices if the convexity of the cost function is below some threshold, but they increase price otherwise. The threshold level relates to the market structure. However, if consumer valuations are high, improvements in advertising technology reduce price. An analysis of the impact of advertising technology on a firm’s profits shows that improvements in technology always improve profits when consumer valuations are high but not when valuations reflect other levels.
Biography
Wilfred Amaldoss is Associate Professor of Marketing, Fuqua School of Business, Duke University. He holds an MBA from the Indian Institute of Management (Ahmedabad) and an MA (Applied Economics) and PhD from the Wharton School, University of Pennsylvania. His research interests include behavioral game theory, experimental economics, advertising, pricing, new product development, and social effects in consumption. His recent publications have appeared in Marketing Science, Management Science, Journal of Marketing Research, Journal of Economic Behavior and Organization, and Journal of Mathematical Psychology. His work received both the John D.C. Little and the Frank Bass Awards. He is an Associate Editor of Management Science and serves on the editorial boards of Journal of Marketing Research and Marketing Science.
Chuan He is Assistant Professor of Marketing, Leeds School of Business, University of Colorado at Boulder. His fields of specialization and research include advertising, search, pricing strategies, and channel contracts. He holds a doctoral degree in Marketing from Washington University in St. Louis and an MA in Economics from the University of Toronto. He serves on the editorial board of Marketing Science.
Journal of Marketing Research, Volume 47, Number 1, February 2010
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