What If Marketers Put Customers Ahead of Profits?
40 Pages Posted: 7 Sep 2011 Last revised: 6 Aug 2014
Date Written: February 19, 2014
We examine a duopoly where one of the firms does not maximize profit, but instead maximizes consumer surplus subject to a minimum profit constraint. Competition between the firms is modeled as a two-stage game, which is solved by backward induction. In the first stage, firms choose product quality levels sequentially, anticipating (simultaneous move) Bertrand price competition in the second stage of the game. The identity of the first moving firm is taken as exogenous, and thus we separately consider the cases of a surplus-maximizing and a profit- maximizing first mover. We consider both cases of convex fixed costs and convex variable costs of producing quality. Our primary goal in conducting the analysis is to evaluate changes in key market outcomes as the surplus-maximizing firm becomes more altruistic in its orientation, as measured by the extent to which it sacrifices profits. As a limiting case, our framework considers competition between a profit-maximizing firm and a non-profit firm. Interim cases may be viewed as models of competition involving a form of “social enterprise,” i.e., a firm organized as a for-profit entity but whose primary objective is to advance consumer welfare. From the analysis, we conclude that the surplus-maximizing firm can deliver significant additional value to consumers by forgoing some of the profit it would have earned as a profit maximizer. However, the effectiveness of this strategy depends upon the cost structure of the industry and which firm is the first mover. With fixed costs of quality, there is a significant first mover advantage. When the surplus-maximizing firm moves first, the tradeoff between sacrificing profits and generating consumer surplus is quite favorable, with surplus approaching its fully efficient level as the surplus-maximizing firm approaches being a non-profit. With variable costs of quality, higher levels of consumer surplus are achieved when the surplus-maximizing firm is the follower in quality choice, although differences in outcomes diminish as the surplus-maximizing firm sacrifices more profit. A key implication of these results is that in order to achieve highly favorable outcomes, the surplus-maximizing firm must move first when production costs are fixed, whereas the order of quality moves is less restrictive when costs are variable.
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