Price Wars and niche discovery in an information economy

Abstract

Electronic goods are flexible and have negligible marginal costs. These features allow a producer of electronic goods to explore pricing schemes, and in particular bundling, that would not be feasible with physical goods. However, they can also make it more di cult for a producer to differentiate itself from competitors offering identical goods. Previous re- search in this area indicates that in markets where producers compete over the sale of identical information goods, cyclical price wars often develop. In this paper, we provide a characterization of the con- ditions that result in price wars and show analytically how the existence of niches within the consumer population can lead duopolist producers to each target separate niches and avoid price wars. In situations where producers have incom- plete information about consumer preferences, and so must learn a strategy, producers will be concerned not only with the relative benefits of niche targeting as opposed to a price war, but also with the loss of revenue incurred in discover- ing a niche. We present experimental evidence describing how the di culty of locating niches changes for an entrant and an incumbent producer as both niche size and the pro- ducers' learning strategies are varied. Our results provide support for the idea that information goods producers are not doomed to engage in price wars at all times, but instead can coexist without direct competition under certain market conditions.