14(40)
markets shares on future profits into account when setting first-period
prices.
14
Since firms' take overall profits into account, they are even willing
to price below costs in the first period, as foregone profits can be recouped
in the second period (Farrell and Klemperer, 2007).
Beggs and Klemperer (1992) model pricing with switching costs on a
growing market in a multi-period setting, where the number of consumers
increases for every time period. With new customers entering the market,
the proportion of locked-in customers is reduced and competition for new
customers is intensified. The intuition is that a steady growth in market size
makes the future relatively more important, because the amount of new
customers that can be locked-in (and exploited) is increasing.
The market size in terms of the number of competing firms also has
implications for penetration pricing. This can be illustrated with an example
of a monopolist; if consumers have nowhere else to go there is no role for
penetration pricing or introductory offers (Farrell and Shapiro, 1988). In
sum, the effect of switching costs on current-period prices is intensified by
the number of competing firms. The difference in the pricing schedule
between first-stage services and follow-on services therefore increases
as the number of competing firms increases.
3.2
Summary
The theoretical framework outlined above offers two interrelated reasons
for why price competition is more intense for diagnostic services compared
to therapeutic services. First, consumers have more information about first-
stage services compared to follow-on services as the former is purchased
with some frequency. Consumers’ demand for first-stage services is
therefore relatively more price sensitive. Second, consumers face costs
for switching provider between the first and second stage and thus find it
cheaper to buy all services from the same provider. Consequently, demand
for follow-on services is relatively less price sensitive. New customers are
valuable from the perspective of the provider, because of their follow-on
purchases.
Naturally, therapeutic services will on average be more expensive than
diagnostic services, because they are generally more complicated and time
consuming. However, it follows from the reasoning i
that the price
difference between services will
increase
with the intensity of competition.
This is because i) competition will have greater effects on services for
which demand is sensitive to price and ii) it becomes more important for
providers to lock in consumers as the number of competitors increases.
Thus, changes in competition would be reflected by changes in the price
difference across services.
14
See Klemperer (1995) for a thorough discussion of the model.
