Competition and Contracting in Service Industries

30 Pages Posted: 26 Jan 2008 Last revised: 6 Sep 2011

See all articles by Ramesh Johari

Ramesh Johari

Stanford University

Gabriel Y. Weintraub

Stanford Graduate School of Business, Stanford University; Columbia University - Columbia Business School - Decision Risk and Operations

Multiple version iconThere are 2 versions of this paper

Date Written: January 2008

Abstract

Two very different contractual structures are commonly observed in service industries with congestion effects: service level guarantees (SLGs) and best effort (BE) service. We analyze the impact of these contractual agreements on market outcomes in oligopolistic industries. First, we consider a model where firms compete by setting prices and SLGs simultaneously. The SLG is a contractual obligation on the part of the service provider: regardless of how many customers subscribe, the firm is responsible for investing so that the congestion experienced by all subscribers is equal to the SLG. We then consider the BE contractual model where firms compete by setting prices and investment levels simultaneously. With BE contractual agreements, firms provide the best possible service given their infrastructure, but without an explicit guarantee. Using the Nash equilibria (NE) of the games played by firms, we compare these competitive models in terms of the resulting prices, service levels, firms' profits, and consumers' surplus. We first show that the SLG game can be reduced to a standard pricing game, greatly simplifying the analysis of this otherwise complex competitive scenario. We then compare the SLG game with the BE game; equilibria for the BE is characterized in a previous paper. Using these results we show that in the case of constant returns to investment, while the NE price for the SLG game is perfectly competitive, firms obtain positive markups in the unique NE for the BE game. We also study the firms' choice of the strategy space, i.e., whether to offer SLG or BE contracts to the consumer, and find that competition is intensified if even one firm chooses to offer SLG contracts. Our results contribute to the basic understanding of competition and contracting in service industries and yield insight into business and policy considerations.

Keywords: competition, game theory, contracting, services, congestion, pricing

JEL Classification: L13, L21, L80

Suggested Citation

Johari, Ramesh and Weintraub, Gabriel Y., Competition and Contracting in Service Industries (January 2008). Available at SSRN: https://ssrn.com/abstract=1087450 or http://dx.doi.org/10.2139/ssrn.1087450

Ramesh Johari (Contact Author)

Stanford University ( email )

473 Via Ortega
Stanford, CA 94305-9025
United States

Gabriel Y. Weintraub

Stanford Graduate School of Business, Stanford University ( email )

Stanford, CA 94305
United States

Columbia University - Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
131
Abstract Views
930
rank
194,105
PlumX Metrics