Price-Quality Strategies of Two Competing Firms with a Homogeneous Preference

Abstract

This paper studies the price-quality strategies of two competing firms where consumers have a homogeneous preference. We use a microeconomic approach to investigate these strategies. Given the consumer demand, a duopolistic setting is described where each of two firms decides both the price and quality levels that maximize their profits. We develope a linear model for price-quality duopolistic competition with a heterogeneous preference presented by Banker et al. and apply it to that with a homogeneous preference. In our model, linearity is assumed for the demand function and cost function for quality improvement. The demand functiton is characterized as a function of product "value", which incorporates price and quality levels. Based on this model, we investigate the optimal price-quality strategies of the firms and the competition resulted from these strategies. It is shown that one-sided competition of price or quality can occur under some demand structures. We furthermore consider a complementary firm with competitive firms and the vertical alliance of two firms. The alliance effect can be evaluated by the difference of profits between the pre- and post-alliance of the two firms. The difference of "value" is also evaluated as an effect for consumers. We derive both of them and observe the alliance effect qualitatively. It is shown that the vertical alliance has a positive effect under strong quality-elastic demand, but it is not necessarily an effective strategy under other environments. Some numerical experiments are conducted in order to illustrate the usefulness of our analytical results.