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Demonstrations and Price Competition in New Product Release

We consider strategic information provision in a model of price competition. Our model of demonstrations may represent product trial, samples, return policies, reviews, or any other means by which firms give consumers exposure to products before the consumers commit to purchase decision. A firm releases an innovative product, which may benefit only some consumers. By providing demonstrations, the firm gives consumers an opportunity to better learn about their own value for the innovation. More information simultaneously increases the expected valuation of those who receive favorable impressions of the new product (the product differentiation effect), while also decreasing the share of consumers with favorable impressions (the market segmentation effect). Depending on whether the firm’s demonstration policy is chosen before or after prices are set, the innovating firm either designs its demonstration policy to reduce subsequent price competition or to persuade consumers to purchase its product given the prevailing prices. When prices respond to the demonstration policy, the firm prefers to make its demonstrations as informative as possible, generating the greatest amount of product differentiation and market segmentation, as this minimizes the intensity of price competition in the pricing stage. In contrast, when the firm adjusts its demonstration policy in response to prices, the product differentiation effect can increase demand for the innovation, while the market segmentation effect reduces it. Consequently, the innovating firm prefers only a partially informative demonstration, designed to maximize its market share. In this case, the ability to offer demonstrations can lead to the innovating firm collecting the monopoly profit.

We show how firms can harness the market segmentation and product differentiation effects of demonstrations to increase industry profits and to gives themselves a competitive advantage. The strategic effects of demonstrations depend crucially on the flexibility of prices within the industry. When prices are flexible, demonstrations are used to segment the market and reduce price competition. When prices are sticky, unable to respond to changes in demonstration policies, demonstrations play a persuasion role, as the firm tries to convince as many consumers as possible to purchase its product. Finally, we show that while demonstrations play a similar role to capacity limits in dampening price competition (Gelman and Salop 1983), they may also positively influence the product valuation for some consumers.

Boleslavsky, Raphael, Christopher S. Cotton, and Haresh Gurnani. “Demonstrations and Price Competition in New Product Release.Management Science (2016): n. pag.