Price and Quality Decisions in Heterogeneous Markets

Document Type : Article

Authors

Department of Industrial Engineering, Sharif University of Technology, Tehran, Iran

Abstract

This paper analyzes the optimal price and quality decisions of a retailer for its different
stores in a heterogeneous market. The consumers are assumed to be heterogeneous in their
willingness to pay for quality and are non-uniformly distributed in the market. This type of
heterogeneity which is identified based on income disparity can have important implications
for a retailer’s optimal policy. The specific objective of this paper is to investigate how the
distribution of consumers’ types in the market and their travel costs affect the optimal setting
of price and quality levels among different stores of a retailer. Our results express that the
geographical disparity of willingness to pay plays a significant role in the differentiation and
targeting strategy of a retailer. Comparative analysis shows that the widely adopted assumption
of uniform distribution of consumers in the literature leads to non-optimal decisions where the
distribution of consumers is non-uniform in a real-world situation.

Keywords


References:
1. Hansen, K. and Singh, V. "Market structure across retail formats", Marketing Science, 28(4), pp. 656-673 (2009).
2. Petro, G. "Department store pricing no easy task (part 4 of 4)",https://www.forbes.com/sites/ gregpetro/2013/01/10/department-store-pricing-no-e asy-task-part-4-of-4/#6121d87a103a (2013).
3. Lieber, C. "Buyer beware: What you're actually getting at outlet stores", https://www.racked.com/ 2014/10/8/7573957/outlet-mall-stores (2014).
4. Kestenbaum, R. "Soaring off-price retail chains may be set for a fall", https://www.forbes.com/sites/ richardkestenbaum/2017/11/15/the-off-price-busines s-is-more-troubled-than-it-looks/#782c25871554
(2017).
5. NCL. "New study reveals disturbing price variation within chain retailers", https://www.nclnet.org/ new study reveals disturbing price variation within chain retailers (2013).
6. Steinhauer, J. "Cost of necessities rises in new york", https://www.nytimes.com/2005/02/08/ nyregion/ cost-of-necessities-rises-in-new-yo rk.html? r=0 (2005).
7. Gauri, D.K., Trivedi, M., and Grewal, D. "Understanding the determinants of retail strategy: an empirical analysis", Journal of Retailing, 84(3), pp. 256-267 (2008).
8. Gupta, S. and Chintagunta, P.K. "On using demographic variables to determine segment membership in logit mixture models", Journal of Marketing Research, 31(1), pp. 128-136 (1994).
9. Gulati, N. and Ray, T. "Inequality, neighbourhoods and welfare of the poor", Journal of Development Economics, 122, pp. 214-228 (2016).
10. Booza, J., Cutsinger, J., and Galster, G. "Where did they go?: The decline of middle-income neighborhoods in metropolitan America", Metropolitan Policy Program,Brookings Institution (2006).
11. Berube, A. and Frey, W., A Decade of Mixed Blessings, Washington, DC: Brookings Institution (2002).
12. Cooke, T. and Marchant, S. "The changing intrametropolitan location of high-poverty neighbourhoods in the us, 1990-2000", Urban Studies, 43(11), pp. 1971-1989 (2006).
13. Reardon, S.F. and Bischo, K. "Growth in the residential segregation of families by income, 1970-2009", US 2010 Project (2011).
14. Hotelling, H. "Stability in competition", The Economic Journal, 39(153), pp. 41-57 (1929).
15. Li, Z., Lu, Q., and Talebian, M. "Online versus bricks-and-mortar retailing: a comparison of price, assortment and delivery time", International Journal of Production Research, 53(13), pp. 3823-3835 (2015).
16. Soysal, G. and Krishnamurthi, L. "How does adoption of the outlet channel impact customers' spending in the retail stores: Conflict or synergy?", Management Science, 62(9), pp. 2692-2704 (2015).
17. Ngwe, D. "Why outlet stores exist: Averting cannibalization in product line extensions", Marketing Science, 36(4), pp. 523-541 (2017).
18. Li, Z., Ryan, J.K., and Sun, D. "Selling through outlets: The impact of quality, product development risk, and market awareness", International Journal of Production Economics, 186, pp. 71-80 (2017).
19. Carpenter, J.M. and Moore, M. "Consumer demographics, store attributes, and retail format choice in the us grocery market", International Journal of Retail & Distribution Management, 34(6), pp. 434-452 (2006).
20. Fox, E.J., Montgomery, A.L., and Lodish, L.M. "Consumer shopping and spending across retail formats", The Journal of Business, 77(S2), pp. S25-S60 (2004).
21. Hoch, S.J., Kim, B.-D., Montgomery, A.L., and Rossi, P.E. "Determinants of store-level price elasticity", Journal of Marketing Research, 32(1), pp. 17-29 (1995).
22. Gonzalez-Benito, O., Munoz-Gallego, P.A., and Kopalle, P.K. "Asymmetric competition in retail store formats: Evaluating inter-and intra-format spatial effects", Journal of Retailing, 81(1), pp. 59-73 (2005).
23. Gabszewicz, J.J. and Thisse, J.-F. "Price competition, quality and income disparities", Journal of Economic Theory, 20(3), pp. 340-359 (1979).
24. Desai, P.S. "Quality segmentation in spatial markets: When does cannibalization affect product line design?", Marketing Science, 20(3), pp. 265-283 (2001).
25. Rochet, J.-C. and Stole, L.A. "Nonlinear pricing with random participation", The Review of Economic Studies, 69(1), pp. 277-311 (2002).
26. Tyagi, R.K. "Technological advances, transaction costs, and consumer welfare", Marketing Science, 23(3), pp. 335-344 (2004).
27. Hernandez, M.A. "Nonlinear pricing and competition intensity in a hotelling-type model with discrete product and consumer types", Economics Letters, 110(3), pp. 174-177 (2011).
28. Shi, H., Liu, Y., and Petruzzi, N.C. "Consumer  eterogeneity, product quality, and distribution channels", Management Science, 59(5), pp. 1162-1176 (2013).
29. Sedghi, N., Shavandi, H., and Abouee-Mehrizi, H. "Joint pricing and location decisions in a heterogeneous market", European Journal of Operational Research, 261(1), pp. 234-246 (2017).
30. Neven, D.J. "On hotelling's competition with nonuniform customer distributions", Economics Letters, 21(2), pp. 121-126 (1986).
31. Tabuchi, T. and Thisse, J.-F. "Asymmetric equilibria in spatial competition", International Journal of Industrial Organization, 13(2), pp. 213-227 (1995).
32. Gupta, B., Pal, D., and Sarkar, J. "Spatial cournot competition and agglomeration in a model of location choice", Regional Science and Urban Economics, 27(3), pp. 261-282 (1997). 
33. Anderson, S.P., Goeree, J.K., and Ramer, R. "Location, location, location", Journal of Economic Theory, 77(1), pp. 102-127 (1997).
34. Calvo-Armengol, A. and Zenou, Y. "The importance of the distribution of consumers in horizontal product di erentiation", Journal of Regional Science, 42(4), pp. 793-803 (2002).
35. Liu, Y. and Weinberg, C.B. "The welfare and equity implications of competition in television broadcasting: the role of viewer tastes", Journal of Cultural Economics, 30(2), pp. 127-140 (2006).
36. Meagher, K.J., Teo, E.G., and Wang, W. "A duopoly location toolkit: Consumer densities which yield unique spatial duopoly equilibria", The BE Journal of Theoretical Economics, 8(1), pp. 1-23 (2008).
37. Guo, W.-C. and Lai, F.-C. "Prices, locations and welfare when an online retailer competes with heterogeneous brick-and-mortar retailers", The Journal of Industrial Economics, 65(2), pp. 439-468 (2017).
38. Benassi, C., Chirco, A., and Colombo, C. "Vertical dierentiation beyond the uniform distribution", Journal of Economics, 126(3), pp. 221-248 (2019).
39. Liu, Y. and Tyagi, R.K. "Outsourcing to convert fixed costs into variable costs: A competitive analysis", International Journal of Research in Marketing, 34(1), pp. 252-264 (2017).
40. Xin, M. and Choudhary, V. "It investment under competition: The role of implementation failure", Management Science, 65(4), pp. 1909-1925 (2018).
41. Ishibashi, I. and Matsushima, N. "The existence of low-end firms may help high-end firms", Marketing Science, 28(1), pp. 136-147 (2009).
42. Galata, G., Bucklin, R.E., and Hanssens, D.M. "On the stability of store format choice", Research Paper, Anderson Graduate School of Management, UCLA (1999).
43. Lacourbe, P. "A model of product line design and introduction sequence with reservation utility", European Journal of Operational Research, 220(2), pp. 338-348 (2012).