Quality differentiation and firms’ choices between online and physical markets

Yijuan Chen*, Xiangting Hu, Sanxi Li

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    20 Citations (Scopus)

    Abstract

    We study firms’ choices between online and physical markets with respect to product quality and competition, and examine consequences of transparency policies on price competition and market structure. We investigate two contrasting forces. First, since consumers cannot fully inspect an online product's quality prior to purchase, conventional wisdom and some of the literature suggest that this attracts low-quality products to the online market (a pooling effect). On the other hand, the literature on vertical product differentiation indicates that a firm with a lower-quality product may prefer to reveal its product quality in the physical market because quality differentiation helps alleviate price competition (a differentiation effect). We show that an entrant firm with product quality lower than that of the offline incumbent may choose the physical market, whereas the entrant with a quality higher than the incumbent's may sell online. More generally the two contrasting forces can give rise to a wide range of product quality—from low-end to high-end—in both markets.

    Original languageEnglish
    Pages (from-to)96-132
    Number of pages37
    JournalInternational Journal of Industrial Organization
    Volume52
    DOIs
    Publication statusPublished - 1 May 2017

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