Two-dimensional vertical differentiation with attribute dependence
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Two-dimensional vertical differentiation with attribute dependence Jose´ A. Novo-Peteiro1 Received: 1 March 2019 / Accepted: 22 May 2020 / Published online: 11 June 2020 Springer-Verlag GmbH Austria, part of Springer Nature 2020
Abstract This paper studies how the type and magnitude of the interaction between quality characteristics determine the nature of the differentiation strategies of firms. The vertical differentiation models with multi-characteristic product preferences consider that the characteristics are independent. We incorporate a non-additive component into a two-dimensional model. Sufficiently high attribute dependence gives rise to maximal differentiation in both qualities: if the qualities are complements, one firm offers the highest quality in both attributes, while the other firm the lowest; on the other hand, if the qualities are substitutes, each firm specializes in one of the qualities. The usual outcome with maximal differentiation in one quality dimension and minimal in the other is achieved if there is low or no attribute dependence. In our model, the magnitude of attribute dependence determines whether differentiation relaxes or intensifies subsequent price competition. Some examples from the banking sector are presented to illustrate the model. Keywords Vertical differentiation Attribute dependence Oligopoly equilibrium Nonprice competition
JEL Classification L13 D43 L15
1 Introduction Firms often compete in a multicharacteristic space where the decision made about one product feature can be influenced by decisions related to the other product features. This implies that the incentive to provide quality may depend on how the & Jose´ A. Novo-Peteiro [email protected] 1
Department of Economics, University of A Corun˜a, Campus de Elvin˜a s/n, 15071 A Corun˜a, Spain
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goods’ overall positioning in the characteristics space is affected (Degryse and Irmen 2001a). Beside cost-side motivations related to scope economies in the provision of quality dimensions, there are motivations that originate in consumer preferences: the valuation of changes in one characteristic frequently depends on the level of other characteristics due to a relationship of either complementarity or substitutability among them. However, the literature on multi-attribute preferences has mainly focused on the pure effects of competitive positioning along each dimension (for example Ansari et al. 1998; Irmen and Thisse 1998). As Degryse and Irmen (2001b) point out, this requires the assumption of attribute independence, or in other words, an additive valuation of attributes by the customers. The role of attribute dependence in the firm’s product placement decisions has been studied as an interaction between vertical and horizontal differentiation (Neven and Thisse 1990; Degryse 1996; Canoy and Peitz 1997; Degryse and Irmen 2001a, b; Piga and Poyago-Theotoky 2005). This paper contributes to this literature by introducing attribute dependence
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