Service Capacity and Price Promotion Wars

Junhyun Bae (), Li Chen () and Shiqing Yao ()
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Junhyun Bae: School of Business Administration, Oakland University, Rochester, Michigan 48309
Li Chen: Samuel Curtis Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853
Shiqing Yao: Monash Business School, Monash University, Melbourne, Victoria 3145, Australia

Management Science, 2022, vol. 68, issue 12, 8757-8772

Abstract: Firms often engage in price promotion wars to gain market share from their competitors. However, poor customer satisfaction as a result of limited service capacity may significantly impact such a pricing strategy. In this paper, we consider a two-firm price competition model in which customers’ purchase decisions are affected by their anticipation of a poor service encounter. Our equilibrium analysis reveals that firms would be less aggressive in engaging in price cutting when customers care more about service quality and when service capacity is relatively low. Interestingly, when service capacity is close (but not exact) to covering one half of the total market demand, firms would adopt a mixed strategy with randomized pricing, driven by unilateral motives to either capture more market share (by lowering prices) or increase profit margin (by raising prices). We further show that having a superior service capacity presents a competitive advantage for a firm and such advantage can be preemptive. In an extended two-period model that allows for customer switching after a poor service encounter, we find that when service capacity is relatively low, firms may offer deeper price discounts in the first period if customers are forward looking than if they are myopic. Our numerical study confirms that the main qualitative insights obtained in our base model continue to hold when the customer switching behavior is considered.

Keywords: service capacity; customer satisfaction; price competition; promotion; switching cost (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:12:p:8757-8772

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