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On the Effects of Consumer Search and Firm Entry in a Multiproduct Competitive Market

Operations and Information Management, The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104
Operations and Information Management, The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104
School of Business Administration, University of Miami, Coral Gables, Florida 33146
cachon{at}wharton.upenn.edu
terwiesch{at}wharton.upenn.edu
yxu{at}miami.edu

This paper studies a model in which consumers search among multiple competing firms for products that match their preferences at a reasonable price. We focus on how easier search, possibly due to the adoption of search-facilitating technologies such as the Internet, influences equilibrium prices, assortments, firm profits, and consumer welfare. Conventional wisdom suggests that easier search creates a competition-intensifying effect that puts pressure on firms to lower their prices and reduce assortments. However, in our model we demonstrate that search also exhibits a market-expansion effect that encourages firms to expand their assortment—easier search means that each firm is searched by more consumers. Because of broader assortments, consumers are more likely to find products that better match their ideal preferences, improving the efficiency of the market. In fact, we demonstrate that the market-expansion effect can even dominate the competition-intensifying effect potentially leading to higher prices, broader assortments, more profits, and expanded welfare.

Key Words: search; Internet; price competition; assortment; product variety; long-tail phenomenon; game theory; differentiated competition
History: Received: January 31, 2006;