Quantitative Marketing and Economics

Using data from the 128-bit video game industry I evaluate the impact technologically tying has on the intensity of console price competition and the incentives for hardware firms to tie their produced software to their hardware. Tying occurs when a console hardware manufacturer produces software that is incompatible with rival hardware. There are two important trade-offs an integrated firm faces when implementing a technological tie. The first is an effect that increases console market power and forces hardware prices higher. The second, an effect due to the integration of the firm, drives prices lower. A counterfactual exercise determines technological tying of hardware and software increases console price competition; console makers subsidize consumer hardware purchases in order to increase video games sales, in particular their tied games, where the greatest proportion of industry profits are made. I also determine technological tying to be a dominant strategy for hardware manufacturers when software development costs are low.

Extant theoretical models suggest that greater consumer loyalty increases a firm’s market power and leads to higher prices and fewer price promotions (Klemperer, Quarterly Journal of Economics 102(2):375–394, 1987a, Economic Journal 97(0):99–177, 1987b, Review of Economic Studies 62(4):515–539, 1995; Padilla, Journal of Economic Theory 67(2):520–530, 1995). However, in some markets large, national brands that are able to generate more consumer loyalty than their rivals offer lower prices and promote more frequently. In this paper, we develop a two-period game-theoretic, asymmetric duopoly model in which firms differ in their ability to retain repeat, loyal buyers. In this market, we demonstrate that it is optimal for a firm that generates more loyalty to offer a lower average price and promote more frequently than a weaker competitor. Numerical analysis of a more general infinite period version of this asymmetric model leads to three additional results. First, we show that there is an inverted-U relationship between a weak firm’s ability to attract repeat, loyal consumers and strong firm profits. Second, we show that the relative ability of firms to attract repeat buyers affects whether serial and contemporaneous price correlations are positive or negative. Finally, we highlight the effect of dynamics on firms’ expected prices and profits.

Increased competition can result in market efficiency. However, alternatively, it may provoke unethical behavior by sellers attempting to avoid losses—a risk that may be greater in credence goods markets, where consumers find it difficult to determine the value of goods or services received. The New York City (NYC) taxi market allows us to investigate how increased competition due to the launch of green-colored taxis (to serve only certain parts of NYC) may lead to fraudulent behavior by drivers of the established yellow taxis. An empirical study of more than 17 million matched yellow taxi trips revealed that fraudulent behavior was most prevalent on routes in which drivers faced increased competition for both pickups and post-drop-off pickups. However, after the launch of green taxis, there was no significant change in the trip distances of yellow taxis for rides subject to a flat-rate fare or for trips to/from office buildings where passengers were more familiar with optimal routes.

One of the puzzles of store-level scanner data is the lack of a dip in quantity sold in the weeks following a promotion. Such a dip is predicted by a consumer inventory model. During a promotion consumers buy more, not only for current consumption, but stockpile for future consumption. The predictions of such a model have been confirmed by household-level data yet seem harder to find in aggregate brand- or category-level data. We re-examine this puzzle and reach two conclusions. First, the effects at the household-level are present, but are much smaller than previously found. Our estimates are different because we control for household heterogeneity in a more general way than most previous work. This suggests that since the effects are small they might be harder to spot in aggregate data. Second, we show that the dip is present in the aggregate data, once we control for additional promotional activity, like feature and display. The latter has an opposing dynamic effect that masks the existence of the post-promotion dip.

Researchers and business thought leaders have emphasized that firms must think and act with a long-term horizon when managing customer relationships. We demonstrate that, in contrast to this widely held view, profits in competitive environments may be maximized when firms ignore the future and instead maximize period-by-period profits from customers. Intuitively, while a long-term focus yields more loyal customers, it greatly increases short-term price competition to gain and keep customers. Consequently, overall firm profits and customer lifetime value may be lower when firms directly maximize multi-period profits from customers. Specifically, we analyze a model with segment-level pricing where firms in a duopoly can choose between period-by-period and multi-period profit maximization and demonstrate that, in many cases, a symmetric focus on period-by-period profit maximization emerges as the Pareto-dominant Nash equilibrium. We extend the model in two directions. First, we demonstrate that this superiority of the short-term focus endures even when a revenue expansion effect applies—that is, when customer loyalty leads to enhanced revenues. Second, we examine the case where customers are strategic and incorporate the long-term implications of their choices into their decision-making. Here we demonstrate that it may pay for firms to be myopic even when customers are strategic. The focus on multi-period surplus makes customers less price sensitive to price variations at the early stage of the game. Consequently, the focus on maximizing period-by-period profits enables the firms to charge higher upfront prices and leverage this lower price sensitivity into higher profits. Overall, our results highlight the paradox that, when it comes to managing customer relationships in competitive environments, a short-term focus may constitute the optimal long-term strategy.

Frequent shopper programs are becoming ubiquitous in retailing. Retailers seem unsure however about whether these programs are leading to higher loyalty, or to higher profits. In this paper we analyze data from a U.S. supermarket chain that has used a number of frequent shopper rewards to improve sales and profitability. We find that while these programs are profitable, this is only because substantial incremental sales to casual shoppers (cherry pickers) offset subsidies to already loyal customers. In this way our findings are inconsistent with existing theories about how frequent shopper programs are supposed to work. We construct our own Hotelling-like model that explicitly models cherry picking behavior and show that its predictions match the data quite closely. We further test the predictions of our model by characterizing the impact of such programs on trip frequency and basket size. We then use the model to examine more complex scenarios. For example, our analysis suggests that frequent shopper programs may be unprofitable if they eliminate all cherry picking. This may explain why some retailers seem dissatisfied with their programs. We end by proposing a solution that retains the benefits of the frequent shopper programs and yet continues to let supermarkets benefit from price discrimination.