Dynamic Competition with Customer Recognition and Switching Costs: Theory and Application (Management Project)

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This project aims to contribute to our understanding of dynamic interaction in duopoly markets. Chapter 1 motivates the study and offers a brief overview of the results. In Chapter 2 I study the dynamic equilibrium of a market characterized by repeat purchases. Such markets exhibit two common features: customer recognition, which allows firms to price discriminate on the basis of purchase history, and consumer switching costs.

Both features have implications for the competitiveness of the market and consumer welfare but are rarely studied together. I employ a dynamic framework to model a market with customer recognition and switching costs. In contrast to earlier studies of dynamic competition with switching costs, these costs are explicitly incorporated in the demand functions. Two sets of market equilibria are characterized depending on the size of the switching cost.

For all values of the switching cost, customer recognition gives rise to a bargain-then-ripoff pattern in prices and switching costs amplify the loyalty price premium. When switching costs are low, there is incomplete customer lock-in in steady state, firm profits increase in the magnitude of the switching cost and introductory offers do not fall below cost. When switching costs are high, there is complete customer lock-in in steady state, firm profits are independent of switching costs and introductory prices may fall below cost.

Under incomplete lock-in and bilateral poaching, switching costs do not affect the speed of convergence to steady state; under complete customer lock-in and no poaching from either firm, convergence to steady state occurs in just one period. The model also suggests that imperfect customer recognition leads to lower profits relative to both uniform pricing and perfect customer recognition. In Chapter 3 I use the market framework developed in Chapter 2 to examine the perception that imperfect competition hinders information sharing among rivals in games of random matching. In contrast to previous studies of information sharing, I propose a new channel through which competition may deter information sharing. This approach reveals a key role for firm liquidity by showing that information sharing among rivals is more likely to arise in markets populated by more liquid firms.

Employing a dynamic duopoly framework, in which competition intensity varies with the degree of product differentiation, consumer switching costs and consumer patience, I show that more intense market competition can weaken the disincentives associated with disclosing information to a rival. I test the model’s predictions using firm-level data on the information-sharing practices of agricultural traders in Madagascar. As predicted by the model, traders operating in liquid markets are shown to be more likely to share information about delinquent customers. This result is robust to the use of two alternative measures of liquidity, of which one is credibly exogenous, and two alternative ways of defining market liquidity. Furthermore, traders who report more intense competition in their market are found to be significantly more likely to share information.
Source: University of Maryland
Author: Grozeva, Vesela Dimitrova

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