The Impact of Competitive Entry in a Developing Market Upon Dynamic Pricing Strategies

Abstract

This paper analyzes dynamic pricing strategies for new durable goods in a two-period context. The first period is characterized as a monopoly market structure for a new product having dynamic demand. The second period begins when a new firm enters the market, and thereby changes the market structure to a duopolistic one. We begin by analyzing the pricing strategies of three types of monopolists: nonmyopic, myopic and “surprised.” A nonmyopic monopolist is a first entrant who perfectly predicts the competitive entry. A myopic monopolist totally discounts the duopolistic period, and a “surprised” monopolist is a first entrant who has the longer time horizon of the nonmyopic monopolist, but who does not foresee the competitive entry. Our results indicate that the nature of these pricing strategies may be quite different. It is optimal for the nonmyopic firm to price its product at a higher level than the myopic monopolist. Additional results indicate under what circumstances the “surprised” monopolist will price too high during the monopoly period. The intuition behind these results is the fact that the myopic monopolist overestimates competition while the surprised monopolist underestimates it. We also characterize the nature of the dynamic equilibrium prices that will prevail during the competitive period. For example, we show that products having higher prices (because of cost differences) will exhibit a more rapid rate of price decline. Moreover, a discontinuity in the first entrant's pricing strategy, as a response to a second entry—which is often observed in the market place—is also captured by our model. Because these analyses are limited to situations where the time of second entry is predictable, a scenario that fits our model better would be the health-care equipment industry where a specified period of government observation and/or testing is required. Immediate extensions of our model should include a discount factor and learning effects on both costs and demand.