Endogenous Differentiation of Information Goods Under Uncertainty

ACM Electronic Commerce, 2001

Posted: 7 Apr 2007

See all articles by Robert S. Gazzale

Robert S. Gazzale

University of Toronto - Department of Economics; Williams College - Department of Economics

Jeffrey K. MacKie-Mason

UC Berkeley; University of Michigan

Abstract

Information goods can be reconfigured at low cost. Therefore, firms can choose how to differentiate their products at a frequency comparable to price changes. However, doing so effectively is complicated by uncertainty about customer preferences, compounded by the fact that the search for a good product niche is carried out in competition with other searching firms. We study two firms that differentiate their information goods. The firms simultaneously compete in product configuration and price. We assume a non-uniform distribution of consumers: the largest number prefer a product located at a "sweet spot," but the rate at which the customer density falls off away from this product configuration is unknown. Our characterization reflects the standard tradeoff between exploitation (current profit) and exploration (learning to enhance future profit). In our model firms balance current profits from competing for a mass and a niche market, while learning about the profitability of these alternative strategies. We show that the amount of learning that firms will undertake depends on the convexity or concavity of the profit function in the rate of demand fall-off. In our model firms have an incentive to learn, and can use both price and product configuration in order to explore. We show that the ability to explore in product characteristic space leads to a previously unidentified consequence of learning: attenuation of competition. The incentive to learn induces firms to differentiate their products more than they would if the value of learning were ignored. This leads to decreased direct competition with rivals, and thus higher prices and profits than if the firms were acting myopically. Thus, we might expect that when firms are not well informed about consumer preferences for information goods --- as might be especially true in new markets for innovative products --- product diversity will be higher and direct competition will be smaller than might otherwise be expected.

Suggested Citation

Gazzale, Robert S. and MacKie-Mason, Jeffrey K., Endogenous Differentiation of Information Goods Under Uncertainty. ACM Electronic Commerce, 2001, Available at SSRN: https://ssrn.com/abstract=978049

Robert S. Gazzale (Contact Author)

University of Toronto - Department of Economics ( email )

150 St. George Street
Toronto, Ontario M5S 3G7
Canada
416.978.2123 (Phone)

HOME PAGE: http://www.economics.utoronto.ca/gazzale/

Williams College - Department of Economics ( email )

24 Hopkins Hall Drive
Williamstown, MA 01267
United States

Jeffrey K. MacKie-Mason

UC Berkeley ( email )

102 South Hall
Berkeley, CA 94720-4600
United States

HOME PAGE: http://jeff-mason.com

University of Michigan ( email )

Ann Arbor, MI 48109-1092
United States

HOME PAGE: http://http:/jeff-mason.com/

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