Competition with Aftermarket Power when Consumers are Heterogeneous

Journal of Economics and Management Strategy, Forthcoming

61 Pages Posted: 22 Mar 2013 Last revised: 31 Jul 2016

Dainis Zegners

Erasmus Univeristy Rotterdam School of Management

Tobias Kretschmer

Ludwig Maximilian University of Munich - Faculty of Business Administration (Munich School of Management); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 24, 2016

Abstract

We study a model of competitive foremarkets and partly monopolized aftermarkets. We show that high aftermarket power prompts firms to engage in inefficiently aggressive below-cost pricing in the foremarket. This inefficiency is driven by the presence of consumers with valuations below marginal cost. While for intermediate aftermarket power their presence leads to a competition-softening effect, for high aftermarket power firms attract increasing numbers of unprofitable consumers by aggressively pricing below cost. For high aftermarket power, firms' equilibrium profits can therefore be decreasing in aftermarket power but are always higher than for low aftermarket power. If firms engage in price discrimination by bundling the foremarket and aftermarket goods or by reducing their aftermarket power, they avoid selling to unprofitable consumers but also reduce the competition-softening effect. This decreases firms' equilibrium profits but increases consumer and social welfare.

Note: An earlier version of this article circulated under the title "Why Aftermarket Can Be Bad for Firms."

Keywords: Aftermarkets, Bundling, Consumer Heterogeneity

JEL Classification: L11, L41

Suggested Citation

Zegners, Dainis and Kretschmer, Tobias, Competition with Aftermarket Power when Consumers are Heterogeneous (July 24, 2016). Journal of Economics and Management Strategy, Forthcoming . Available at SSRN: https://ssrn.com/abstract=2236121 or http://dx.doi.org/10.2139/ssrn.2236121

Dainis Zegners (Contact Author)

Erasmus Univeristy Rotterdam School of Management ( email )

Tobias Kretschmer

Ludwig Maximilian University of Munich - Faculty of Business Administration (Munich School of Management) ( email )

Kaulbachstr. 45
Munich, 80539
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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