Demonstrations and Price Competition in New Product Release

Abstract

We incorporate product demonstrations into a game theoretic model of price competition. Demonstrations may include product samples, trials, return policies, online review platforms, or any other means by which a firm allows consumers to learn about their value for a new product. In our model, demonstrations help individual consumers to learn whether they prefer an innovative product over an established alternative. The innovative firm controls demonstration informativeness. When the innovative firm commits to demonstration policies and there is flexibility in prices, the firm is best off offering fully informative demonstrations that divide the market and dampen price competition. In contrast, when a firm can adjust its demonstration strategy in response to prices, the firm prefers only partially informative demonstrations, designed to maximize its market share. Such a strategy can generate the monopoly profit for the innovative firm. We contrast the strategic role of demonstrations in our framework with the strategic role of capacity limits in models of judo economics, which also allow firms to divide a market and reduce competition. This paper was accepted by J. Miguel Villas-Boas, marketing.