The Effect of Quality Decisions on Competitive Strategy

Abstract

This dissertation analyzes how quality decisions are given and their respective effects on strategic marketing variables such as pricing and advertising decisions. I study quality decisions in three unique settings in three essays. The first essay studies the strategic interaction between firms producing strictly complementary products. I show that both value-capture and value-creation problems occur when such products are developed and sold by separate firms. Separate firms charge higher prices and choose lower levels of quality. A royalty structure may mitigate the value-capture problem to some extent at the expense of a more serious value-creation problem. Somewhat surprisingly, the result can change with competition. Specifically, when there is vertically differentiated competition in one of the product markets, the value-creation problem is reduced, opening the door to the possibility of a win-win-win-win situation in which all firms and consumers are better off. The second essay studies the strategic decisions of vertically differentiated firms that promote their products online utilizing display or search engine advertising. In such a setting firms' decisions may lead to informational disparity in the marketplace that softens price competition. Specifically, a low-quality firm may choose not to run a display advertising campaign, even when administering such a campaign is costless, if the degree of vertical differentiation between the goods is small. Moreover, as the degree of advertising effectiveness goes up the low-quality firm can be better off (despite not advertising). In the case of search engine advertising, the high-quality firm acquires the top sponsored link over a large range of the parameter space, as the value of advertising is typically greater for it. However, if advertising effectiveness is moderate and vertical differentiation is small, the low-quality firm will win the auction for the top link. The third essay explores quality decisions of media firms that operate in two-sided markets: they sell content to readers and sell advertising space to advertisers. I find that while competition often drives firms to overinvest in quality and charge lower prices relative to a monopolist media firm, there exist conditions whereby competition results in lower quality selected and higher prices.