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A note on pioneering brands, market dominance and technology
Economics Letters 40 (1992) 247-250 North-Holland
247
A note on pioneering brands, market dominance and technology Chong Ju Choi University of Oxford, Oxford, UK
Carlo Scarpa University of Bologna, Bologna, Italy
Received 14 April 1992 Accepted 24 June 1992
Schmalensee (1982) was the first to show in a formal model how a pioneering brand can retain a large market share because in a world of quality uncertainty, consumers may be unwilling to try new brands. Conrad (1983) has analyzed this idea further, in a more realistic competitive environment setting, and in a price leadership model of post entry behavior. The purpose of this note is to examine the effect of such pioneering brand advantages, or market dominance, when there is a technological change that affects product quality.
1. Introduction
Schmalensee (1982) was the first to show in the context of a simple model how a pioneering brand can retain a large market share, because consumers may be unwilling to try new brands. This is because there is uncertainty about product quality, and consumers may be unwilling to incur the costs of experiencing [Nelson (197411 a new brand. Schmalensee concluded that in a market where product quality is uncertain, a pioneering brand may be ‘immune from subsequent entry’. Conrad (1983) has taken this analysis one step further. Conrad has analyzed the more realistic case of a competitive market environment, in the context of a dominant price leadership model. The results of Conrad’s work also confirm Schmalensee’s earlier work. The purpose of this short note is to analyze such market dominance, but focusing on the potential role of technological change. The question we ask is whether a technological change that affects product quality increases or decreases a pioneering brand’s advantage. In analyzing such issues of market dominance, we see similarities with the work of Rosen (1981), the phenomenon of superstar rents and incomes that result due to slightly higher talent or ‘quality’, than that of competitors. Correspondence
to: Chong Ju Choi, University of Oxford, The Queen’s College, Oxford, OX1 4AW, United Kingdom.
0165-1765/93/$06.00
0 1993 - Elsevier Science Publishers B.V. All rights reserved
248
C.J. Choi, C. Scapa
/ Pioneering brands, market dominance and technology
2. Market dominance Pioneering brands are similar to the superstar phenomenon in that there is a certain market dominance by a person or firm. In Rosen’s (1981) superstars model, this dominance leads to high incomes; in Schmalensee’s (1982) and Conrad’s (1983) pioneering brands models, the result is high firm profits. In order to better understand the role of technology on market dominance, we will follow some of the basic elements of Rosen’s (1981) model. Consumers maximize their utility, which depends on n, the quantity of a service purchased, and z, the quality of the service: u
=g(n,
g,,, g,,
z),
with
and g,,,
all greater than 0.
P is the price of the product, s is what the consumer spends to actually consume the service. The full price of the product to the consumer is “X--
P+s
P(z) = (vz - s) can be interpreted quality z is produced:
as a price-quality
indifference
curve. A service or product of
where m denotes the market size and q the producer’s skill. This function has the following assumptions: h, is less than or equal to 0, serving a larger market does not improve the quality of the service or product; h, is greater than 0, which defines skill as an intrinsic quality of the firm or producer; h,, is greater than 0, increasing market size affects quality especially for less skilled firms. On the basis of the above, the profit function for each producer is
R(m, 4) = [oh(q, m)
-s]m-c(m),
where C(m) denotes cost and is positive. The main result of Rosen’s (1981) work relevant for our analysis is that equilibrium market size will be larger for more talented players, or firms. Talent or skill compensates the negative effect of m on z, and thus increases market size. R, and R,, are both greater than 0, this implies that revenue is convex in talent, and increases in skill will reflect more than proportionately on earnings; this is what creates a dominant firm or superstar type effect. The question we ask in this short note is if there is a change in technology that affects ‘product quality’, will this affect the dominant firm versus other firms in a different way. We are thinking of the following situation:
Z=h(q, t),
C.J. Choi, C. Scarpa / Pioneering brands, market dominance and technology
249
where h, and h, are both greater than 0, h,, and h,, are less than 0. We have assumed that a technological change can improve product quality. But this change is larger for the ‘less’ skilled firms or producers. R=m[uh(q,
t) -s]
R, = vmh,
-C(m),
greater than 0, dm
R,, = umh,, + uh -
greater than 0, if h,, is not ‘too negative’.
’ dq
We can now try and determine R, = mvh,
the effects of technology:
greater than 0, which is quite obvious.
The market m is determined
according to
uh( )-s-&=0.
Totally differentiating, dm -=dt
we have
vh, Cr?lnl
and is greater than 0.
There are conflicting effects. R,, is greater or less than 0, depending on which effect is larger. R Wf = vmh,,,
dm dm d2m + uhqqdr + vh,,+ vh,dqdt ’ dq
The second and third terms in the above equation are negative, implying that the fourth term is negative; hqqt is less than 0, implying that R,,, is also less than 0, and thus, net revenue is ‘less convex’ in talent. An improvement in technology makes skill or talent more valuable at the margin, and would thus be an advantage to the dominant firm, only if hqqt is positive and large. This means that technological improvements must be able to substantially reduce the decreasing returns from skills or talent. This seems intuitively quite unlikely. We can conclude that a technological improvement makes the revenue curve flatter, less convex and thus small quality differentials between the dominant firm or superstar, and those of a slightly lower quality, will matter less.
3. Conclusion We showed that the superstars phenomenon analyzed by Rosen (1981) and Adler (1983) has similarities with the pioneering brand advantage works by Schmalensee (1982) and Conrad (1983).
250
The similarity is that both may explain certain instances of ‘market dominance’. The purpose of this short note was to show that technological change may reduce such dominance. This is because a technological improvement makes the revenue curve less convex, thus small quality or talent differentials matter less than before the technological change.
References Adler, M., 1983, Stardom and talent, American Economic Review, March, 208-212. Conrad, C., 1983, The advantage of being first and competition between firms, International Journal of Industrial Organization, 353-364. Nelson, Ph., 1974, Advertising as information, Journal of Political Economy 92, July/Aug., 729-754. Rosen, S., 1981, The economics of superstars, American Economic Review, Dec., 845-858. Schmalensee, R., 1982, Product differentiation advantages of pioneering brands, American Economic Review, June, 349-365.
247
A note on pioneering brands, market dominance and technology Chong Ju Choi University of Oxford, Oxford, UK
Carlo Scarpa University of Bologna, Bologna, Italy
Received 14 April 1992 Accepted 24 June 1992
Schmalensee (1982) was the first to show in a formal model how a pioneering brand can retain a large market share because in a world of quality uncertainty, consumers may be unwilling to try new brands. Conrad (1983) has analyzed this idea further, in a more realistic competitive environment setting, and in a price leadership model of post entry behavior. The purpose of this note is to examine the effect of such pioneering brand advantages, or market dominance, when there is a technological change that affects product quality.
1. Introduction
Schmalensee (1982) was the first to show in the context of a simple model how a pioneering brand can retain a large market share, because consumers may be unwilling to try new brands. This is because there is uncertainty about product quality, and consumers may be unwilling to incur the costs of experiencing [Nelson (197411 a new brand. Schmalensee concluded that in a market where product quality is uncertain, a pioneering brand may be ‘immune from subsequent entry’. Conrad (1983) has taken this analysis one step further. Conrad has analyzed the more realistic case of a competitive market environment, in the context of a dominant price leadership model. The results of Conrad’s work also confirm Schmalensee’s earlier work. The purpose of this short note is to analyze such market dominance, but focusing on the potential role of technological change. The question we ask is whether a technological change that affects product quality increases or decreases a pioneering brand’s advantage. In analyzing such issues of market dominance, we see similarities with the work of Rosen (1981), the phenomenon of superstar rents and incomes that result due to slightly higher talent or ‘quality’, than that of competitors. Correspondence
to: Chong Ju Choi, University of Oxford, The Queen’s College, Oxford, OX1 4AW, United Kingdom.
0165-1765/93/$06.00
0 1993 - Elsevier Science Publishers B.V. All rights reserved
248
C.J. Choi, C. Scapa
/ Pioneering brands, market dominance and technology
2. Market dominance Pioneering brands are similar to the superstar phenomenon in that there is a certain market dominance by a person or firm. In Rosen’s (1981) superstars model, this dominance leads to high incomes; in Schmalensee’s (1982) and Conrad’s (1983) pioneering brands models, the result is high firm profits. In order to better understand the role of technology on market dominance, we will follow some of the basic elements of Rosen’s (1981) model. Consumers maximize their utility, which depends on n, the quantity of a service purchased, and z, the quality of the service: u
=g(n,
g,,, g,,
z),
with
and g,,,
all greater than 0.
P is the price of the product, s is what the consumer spends to actually consume the service. The full price of the product to the consumer is “X--
P+s
P(z) = (vz - s) can be interpreted quality z is produced:
as a price-quality
indifference
curve. A service or product of
where m denotes the market size and q the producer’s skill. This function has the following assumptions: h, is less than or equal to 0, serving a larger market does not improve the quality of the service or product; h, is greater than 0, which defines skill as an intrinsic quality of the firm or producer; h,, is greater than 0, increasing market size affects quality especially for less skilled firms. On the basis of the above, the profit function for each producer is
R(m, 4) = [oh(q, m)
-s]m-c(m),
where C(m) denotes cost and is positive. The main result of Rosen’s (1981) work relevant for our analysis is that equilibrium market size will be larger for more talented players, or firms. Talent or skill compensates the negative effect of m on z, and thus increases market size. R, and R,, are both greater than 0, this implies that revenue is convex in talent, and increases in skill will reflect more than proportionately on earnings; this is what creates a dominant firm or superstar type effect. The question we ask in this short note is if there is a change in technology that affects ‘product quality’, will this affect the dominant firm versus other firms in a different way. We are thinking of the following situation:
Z=h(q, t),
C.J. Choi, C. Scarpa / Pioneering brands, market dominance and technology
249
where h, and h, are both greater than 0, h,, and h,, are less than 0. We have assumed that a technological change can improve product quality. But this change is larger for the ‘less’ skilled firms or producers. R=m[uh(q,
t) -s]
R, = vmh,
-C(m),
greater than 0, dm
R,, = umh,, + uh -
greater than 0, if h,, is not ‘too negative’.
’ dq
We can now try and determine R, = mvh,
the effects of technology:
greater than 0, which is quite obvious.
The market m is determined
according to
uh( )-s-&=0.
Totally differentiating, dm -=dt
we have
vh, Cr?lnl
and is greater than 0.
There are conflicting effects. R,, is greater or less than 0, depending on which effect is larger. R Wf = vmh,,,
dm dm d2m + uhqqdr + vh,,+ vh,dqdt ’ dq
The second and third terms in the above equation are negative, implying that the fourth term is negative; hqqt is less than 0, implying that R,,, is also less than 0, and thus, net revenue is ‘less convex’ in talent. An improvement in technology makes skill or talent more valuable at the margin, and would thus be an advantage to the dominant firm, only if hqqt is positive and large. This means that technological improvements must be able to substantially reduce the decreasing returns from skills or talent. This seems intuitively quite unlikely. We can conclude that a technological improvement makes the revenue curve flatter, less convex and thus small quality differentials between the dominant firm or superstar, and those of a slightly lower quality, will matter less.
3. Conclusion We showed that the superstars phenomenon analyzed by Rosen (1981) and Adler (1983) has similarities with the pioneering brand advantage works by Schmalensee (1982) and Conrad (1983).
250
The similarity is that both may explain certain instances of ‘market dominance’. The purpose of this short note was to show that technological change may reduce such dominance. This is because a technological improvement makes the revenue curve less convex, thus small quality or talent differentials matter less than before the technological change.
References Adler, M., 1983, Stardom and talent, American Economic Review, March, 208-212. Conrad, C., 1983, The advantage of being first and competition between firms, International Journal of Industrial Organization, 353-364. Nelson, Ph., 1974, Advertising as information, Journal of Political Economy 92, July/Aug., 729-754. Rosen, S., 1981, The economics of superstars, American Economic Review, Dec., 845-858. Schmalensee, R., 1982, Product differentiation advantages of pioneering brands, American Economic Review, June, 349-365.