Should a New Entrant Adopt Cost Transparency?

Abstract

Firms are under public pressure to disclose more information about their operations ranging from carbon emissions to product provenance. However, should a new entrant reveal its true cost to consumers when entering a market? This question is intriguing because cost transparency is a double-edged sword: it can increase consumer utility through an additional “booster” value generated by the firm’s transparency, but it can put pressure on the firm to reduce its price especially when the true cost is low.

In this paper, we examine if and when an entrant firm should adopt cost transparency in two settings arising from market entry: (a) a monopolistic setting in which the entrant firm is the only firm in the market; and (b) a duopolistic setting in which a pre-existing incumbent firm is committed to the opaque policy by not revealing its true cost. Our equilibrium analysis generates the following insights.

First, in the monopolistic setting, we find that the entrant firm should adopt the transparent policy only when its true cost is sufficiently high or when the consumer valuation booster generated by cost transparency is sufficiently high. Second, in the duopolistic setting, the entrant firm should adopt the cost transparency policy under similar conditions as in the monopolistic selling model. However, from the perspective of the incumbent, it is interesting to observe that, when the booster associated with cost transparency is large, the incumbent is less aggressive in deterring entry when the entrant firm adopts cost transparency (as opposed to cost opacity). On the contrary, when this booster is low and the entry fee is large, the incumbent is less aggressive in deterring entry when the entrant firm adopts cost opacity (as opposed to cost transparency).

Keywords: Cost Transparency, Fair Price, Differentiation Strategy, Consumer Beliefs