Price and quality competition with quality positions

• Date: 01 March 2018
• DOI: http://doi.org/10.1111/jems.12229
• Published date: 01 March 2018

Received: 31 March 2016 Revised: 27 July 2017 Accepted: 31 August 2017

DOI: 10.1111/jems.12229

ORIGINAL ARTICLE

Price and quality competition with quality positions

Shogo Kurokawa1Nobuo Matsubayashi2

1Department of Administration Engineering,

Faculty of Science and Technology,Keio

University,Yokohama, Japan (Email:

scarletcurio@gmail.com)

2Department of Administration Engineering,

Faculty of Science and Technology,Keio

University,Yokohama, Japan (Email:

nobuo-m@pa2.so-net.ne.jp)

Abstract

In this study, we investigate price and quality decisions in a duopoly in the presence

of firms’ quality positions , which are determined by the quality levels of their exist-

ing core products. Into a standard model of vertical differentiation, we incorporate

a “repositioning cost” that is proportional to the quality differences between firms’

current and new products. By varying the levels of quality positions, we analyze the

impact of this cost on the equilibrium outcomes. Our results show that the presence of

repositioning costs restricts firms’ abilities to improve profitability and differentiate

themselves vertically. As a result, a high-positioned firm does not necessarily have a

competitive advantage overa low-positioned firm, even if the former offers a superior

new product in equilibrium. In addition, if a low-positioned firm is significantly cost-

efficient compared with its rival with regard to repositioning, then that firm can earn

higher profits than those of a high-positioned firm by strategically offering its low-

end product. These results contrast sharply with those based on the standard vertical

differentiation model.

1INTRODUCTION

In many industries, developing new products is one of a firm's most important activities. Past cases have shown that a firm's

sustainability is determined by whether it can develop new products that are adopted successfully by the market. On the other

hand, entering foreign markets, particularly in emerging countries, is another attractive option for firms in advanced countries.

From manufacturers to service providers, there are many examples of firms that haveexpanded their business to other countr ies.

Regardless of whether incumbent firms in the real world develop new products for their home markets or modify existing

products for foreign markets, their activities are affected by their capabilities, including their core technology, sales skills, and

operational know-how. Successfully utilizing these resources to develop new products or modify existing ones improves their

profitability (Barney, 1991). Specifically, when a firm introduces a new product with the same level of quality as its existing

product, it only incurs setup costs related to the introduction of the new product. Otherwise, firms must incur some additional

cost, which depends heavily on their current capabilities. The extent of this cost is determined by the degree of “repositioning”

that firms must undertake, which is based on the difference in quality between its current and new products. Therefore, we refer

to this type of cost as a “repositioning cost.”

Repositioning costs are present in real-world businesses. For example, Louis Vuitton persists in introducing high-end clothes

and, thus, never offers low-priced products such as those provided by fast fashion chains (e.g., H&M). This fact reflects that

incumbent firms must incur significant costs when changing their product positioning, regardless of whether they increase or

decrease the quality of their products. The following costs arise from repositioning activities: (1) the costs of introducing new

production facilities, (2) educational expenses to acquire know-how, (3) the costs of developing new distribution networks, (4)

marketing costs to acquire customers in new markets, and (5) advertising costs to make consumers aware of the new position.

Note that even if the quality of a new productis lower than that of the existing product, the firm must incur positive repositioning

costs, primarily to maintain its reputation.

J Econ Manage Strat. 2018;27:71–81. © 2017 WileyPeriodicals, Inc. 71wileyonlinelibrary.com/journal/jems