Channel Responses to Brand Introductions: An Empirical Investigation

Abstract

We investigate the effect of competitive entry on manufacturer and retailer pricing behavior. Since the observed price changes can be due to entry-induced changes in a) demand conditions or b) costs, c) manufacturer's competitive behavior, or d) retailer's competitive behavior, a robust empirical model should be able to parse out these four sources of price changes. In order to understand realistic and managerially relevant responses to entry/brand introduction, we model manufacturer and retailer pricing as an outcome of maximizing a combination of shares and profits. This inclusion of shares in the objective function enables us to isolate the impact on prices of the four effects. Furthermore, our formulation of the objective function enables us to parsimoniously capture the full range of competitive behavior from very competitive to collusive outcomes. This formulation builds on well-established theoretical literature (including the strategic incentive design and entry literatures), anti-trust evidence and managerial practice the notion that firms' competitive conduct manifests itself as maximizing not just pure profits but a weighted combination of profits and market shares or sales. As a result, we are able to address the following questions: (1) how do manufacturers change competitive pricing conduct as entry happens? Do some of them price to protect their market shares? Are there any patterns in this behavior in terms of weaker/stronger brands and are these patterns consistent with theoretical predictions? (2) what is the retailer's pricing objective and conduct for each brand? Does this change with entry and in what manner? (3) how does channel power as measured by profit percentages for manufacturer versus retailer change as a result of these brand introductions, and the accompanying changes in competitive conduct? (4) how do these changes in manufacturer and retailer behavior and their power depend on the type of brand introduction i.e. if it is a de novo brand introduction versus a line extension of an established brand?

Our empirical investigation is based on the toothpaste category for the time period January 1993-February 1995. In this period, the category saw three brand introductions in two rounds of entry. We find that incumbent manufacturers' response to brand introductions is a function of the entrant manufacturer's brand introduction stance as well as the threat posed by incumbents. For example, the de novo entrant chooses a non-aggressive brand introduction stance. In response to this brand introduction, incumbent manufacturers price to preserve their market share, and therefore exhibit an aggressive pricing response. On the other hand, line extensions of existing brands enter more aggressively and are, in turn, accommodated more softly by other incumbent manufacturers. We find that the retailer's response to entry is predominantly similar to that of the manufacturers'. When manufacturers respond to brand extensions aggressively by resorting to price cuts, retailers' share of the total channel profits increases; the reverse is true for a soft accommodation of entry. Contrary to what one might expect, the entrant brand is not necessarily disadvantaged relative to incumbent brands in terms of channel profit share. Entrants who can generate good demand pull and who have a soft entry stance can expect more favorable accommodation from retailers and other manufacturers.

Keywords: channels pricing, channels competitive conduct, brand introductions, profit and sales maximization