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Information acquisition for new product pricing

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In industrial markets, new products are often sold before they are developed or produced. To set an optimal price, firms need reliable forecasts of uncertain factors such as market conditions and production costs. In this situation, empirical evidence suggests that many industrial firms are more concerned with estimating production costs than with assessing market conditions to estimate the optimal margin. The resulting cost-based pricing strategy is generally viewed as an inferior strategy. However, information to improve forecasts and thus a price decision is not free. In other words, a cost-based pricing strategy may be optimal given the costs and benefits of information. This paper examines the information acquisition problem for pricing a new product in an industrial market when market conditions as well as production costs are uncertain. Of particular interest is the impact of competition (i.e., product differentiation) on the acquisition of information. The author considers a duopoly with differentiated products where the firms have some prior knowledge but need to acquire more costly information in order to improve their market and cost forecasts for the price decision. He determines the equilibrium amount of new market and new cost information, which yields insights about the importance of cost and market information under different conditions. He then explores the optimal selling and pricing policies for an information vendor, which yields insights about the effect of information supply factors on the acquisition of cost and market information. Competition is a dominant factor for the optimal acquisition of information. Contrary to common intuition, he finds that competition decreases the importance of cost information relative to market information. In other words, a cost-based pricing approach is more appropriate for a monopolist than for duopoly firms, all else equal. Pressure on a product's margin increases the importance of having low production costs, but not necessarily the importance of forecasting costs better than determining the optimal size of the margin. The author finds that higher price sensitivity makes a cost-based pricing approach more appropriate. Competition, however, is different because it also links the information acquisition efforts of competing firms. This strategic interaction for our linear model is different between cost and market information, even though they are used for the sameprice decision. Market information is a strategic complement while cost information is a strategic substitute (as long as the production cost functions are positively correlated). In other words, the value of market information increases when a competitor has similar information, while the reverse holds for cost information. Due to this competitive effect a cost-based pricing approach also tends to be less appropriate whenever the optimal amount of new information is relatively large, for example, when the cost of information is low or prior uncertainty high, that is, in faster-changing industries and for really new products. For cost information, it is also possible that identical firms acquire different amounts of cost information when competition is intense and the cost of information low. Thus, identical firms can have different optimal pricing strategies. Information asymmetries play an important role in explaining firm behaviour and performance. With respect to knowledge about production costs when firms compete on prices, he finds that firm differences can be the result of conscious choice and not just innate endowment or different capabilities. When the prices of cost and market information are set by an external information vendor, he finds that identical duopoly firms always acquire more market than cost information. The amount of market information increases and the amount of cost information decreases with competition, but both amounts are independent of price sensitivity or prior uncertainty. When the firms are of different sizes, the information vendor sets a high price for market information and sells only to the larger firm as long as competition is limited. As a result, a small firm acquires only cost information. When both firms buy market information, the pricing of information may cause a larger firm to buy less market information as competition increases despite the increasing value of market information. The optimal prices of cost and market information show an interesting pattern. Consistent with the positive effect of competition for market information, the optimal price of market information increases with competition. Interestingly, the optimal price for cost information can also increase with competition. This occurs when competition is sufficiently high. A high price limits the purchase of cost information and thus the negative effect of competition.

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