Committed Versus Contingent Pricing Under Competition
Production and Operations Management · 2014 · Volume 23 · Issue 11
Abstract
Should capacitated firms set prices responsively to uncertain market conditions in a competitive environment? We study a duopoly selling differentiated substitutable products with fixed capacities under demand uncertainty, where firms can eithercommitto a fixed priceex ante, or elect to pricecontingently ex post, e.g., to charge high prices in booming markets, and low prices in slack markets. Interestingly, we analytically show that even for completely symmetric model primitives,asymmetricequilibria of strategic pricing decisions may arise, in which one firm commits statically and the other firm prices contingently; in this case, there also exists a unique mixed strategy equilibrium. Such equilibrium behavior tends to emerge, when capacity is ampler, and products are less differentiated or demand uncertainty is lower. Withasymmetricfixed capacities, if demand uncertainty is low, a unique asymmetric equilibrium emerges, in which the firm with more capacity chooses committed pricing and the firm with less capacity chooses contingent pricing. We identify two countervailing profit effects of contingent pricing under competition: gains from responsively charging high price under high demand, and losses fromintensifiedprice competition under low demand. It is the latter detrimental effect that may prevent both firms from choosing a contingent pricing strategy in equilibrium. We show that the insights remain valid when capacity decisions are endogenized. We caution that responsive price changes under aggressive competition of less differentiated products can result in profit-killing discounting.
Keywords
competition, contingent pricing, committed pricing, revenue management, demand uncertainty
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