Competing for Low-End Markets

Recent business research points to the fortune awaiting to be tapped in low-end markets. In this paper, we investigate how the size of the low-end market influences a firm's profits and the pioneering firm's quality choice. As low-valuation consumers increase in a market, on average, consumers' willingness to pay decreases. This may lead us to expect firms' profits to decrease as the size of the low-end market increases. Our analysis shows that, if the size of the low-end market is below a threshold, an increase in the size of the low-end market may actually dampen price competition and improve profits, as firms can then strategically choose their quality levels such that their products are more differentiated. Conventional wisdom also suggests that the pioneering firm will offer a higher-quality product and earn more profits compared with the later entrant. In contrast to this notion of quality advantage, our analysis identifies circumstances in which a pioneer can offer a lower-quality product and yet earn more profits. An experimental test lends support for some of our model's predictions. We further extend the model to consider markets with multiple firms, firms with multiple products, and consumers with limited purchasing power.