This paper provides a model of service provision with homogeneous goods that allows for welfare comparisons between firms engaged in Cournot-type competition and joint-profit maximization. An important factor in this analysis is the role of service provision on the demand for the product. We find that collusion can be social welfare enhancing in a static framework and show that under certain conditions both consumers and producers can benefit from collusion; this occurs if the number of firms in the market exceeds roughly 20.4 firms. Additionally, we present a collusive result that we have not found elsewhere in the literature. Introduction Much of the research on collusion finds that social welfare is maximized when firms are engaged in competition rather than collusion. This is particularly true for static models, with exceptions usually arising when the models are dynamic. Examples of increased social welfare when firms are colluding are often related to quality, advertising, mergers, or research and development related joint ventures (Cellini & Lambertini, 2003; Deltas & Serfes, 2002; Fershtman & Pakes, 2000; Kamien, Muller, & Zang, 1992; Verboven, 1995). (1) Using a static modeling approach, this paper provides a model of service provision with homogeneous goods that allows for welfare comparisons between firms engaged in Cournot-type competition and joint-profit maximization. An important factor in this analysis is the role of service provision on the demand for the product. Unlike other works, we find that collusion can indeed be social welfare enhancing in a static framework. We show that under certain conditions both consumers and producers can benefit from collusion; this occurs if the number of firms in the market exceeds roughly 20.4 firms. Additionally, we have not found a collusive result in any other work that is similar to the one presented in this paper. Much of the remainder of the paper is based on a theoretical model involving mathematical derivations. We would like to briefly mention some aspects of the model and implications for the reader that is not interested in the technical aspects of the work. We assume that the firms are producing, or selling, a homogeneous good with an associated level of service. Our central result, the finding that collusion can be social welfare enhancing, rests on the assumption that firms can engage in service provision which has a cumulative effect on potential buyers. If the effect is sufficiently strong then this induces individuals, who were not previously purchasing the good, to buy the product. These consumers are known as marginal consumers in the economics literature. While the product being sold is identical, with similar amounts of service provided by each firm in equilibrium resulting in similar costs of provision, the nature of the service provided may vary among the firms. Some information may be viewed as bundled with the product but only from a certain firm. For example, one firm may provide a handout containing product information, while another may provide a demonstration regarding usage, and yet another convenient location in the store to view or sample the product. (2) It is also possible to view our findings with firms required to provide both identical types and amounts service provision in equilibrium. The results show that the returns to collusion are greater, with higher total service provision, with greater numbers of firms. This can be interpreted that the pervasiveness of the product, i.e. availability in prime locations within the retailers, encourages the marginal consumer to buy due to repeated viewings at various outlets. (3) However, if the service provision of the various firms is not cumulative, i.e. a firm's sales are not positively affected by the increased service levels of another firm, then collusion results in each firm receiving and equal share of the monopolist's profit and does not result in increased welfare for consumers; the total surplus is constant under this setting with producer and consumer surplus remaining constant regardless of the number of firms in the market. …

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Welfare Enhancing Collusion in a Service Provision Model

We develop a model of optimal service provision and pricing in which the level of service is not viewed as a capacity choice. We study the provision of services in both a non-strategic setting, characterized by a monopoly, and in a strategic setting, a differentiated price duopoly. We find that in both settings increased services lead to increased prices. However, unlike other models, the strategic setting results in greater services than the non-strategic case. Additionally, we discuss the welfare effects for consumers and find that any gains in consumer surplus from increased service provision in the strategic setting are more than offset by the associated higher equilibrium prices. ********** A problem that has received attention in the literature is the level of customer service provided by retailers. One vein of research has linked the provision of service by retailers to fair trade laws and resale price agreements between sellers. This is exemplified by the work of Telser (1960, 1990) and that of Marvel and McCafferty (1996). The argument is that since resale price agreements provide price floors in the resale market, they prevent retailers from selling at low prices to customers that have obtained product information from other sellers. Such agreements, therefore, encourage the provision of service in the form of additional product information by retailers. An implication of this reasoning is that higher service levels are generally associated with higher retail prices. An alternative strand of research has been to regard the level of service provided by retailers as a strategic weapon. De Vany (1976), De Vany and Saving (1983), Koenigsburg (1980), Kalai et al. (1992), Stidham (1992), Li and Lee (1994), and Ilmakunnas (2002) adopt this approach. Earlier work in this area centers on service level as the firm's primary choice variable. More recent work, such as the papers of Stidham (1992), Li and Lee (1994), and Ilmakunnas (2002), study the simultaneous use of price and service capacity as strategic instruments. Ilmakunnas, for instance, develops a model of service capacity choice in which firms, after choosing capacity, compete using price in Bertrand fashion. In the Ilmakunnas model, capacity choices have a negative impact on competitors, since added capacity in one firm decreases the full price (price plus waiting cost) and leads to a flow of customers from the other firm. Two implications of this approach are a negative correlation between service capacity and price, and an underinvestment in service capacity compared to the non-strategic case. The present note extends this second line of research in two ways. First, we develop a model of optimal level of service in which service is not viewed as capacity. Second, we study the provision of services in a non-strategic setting characterized by a monopoly and in a strategic setting, a differentiated price duopoly. We find that in both settings increased services lead to increased prices. However, unlike the Ilmakunnas model, the strategic setting results in greater services than the non-strategic case. Additionally, the effects on consumer welfare are discussed. We conclude with a summary and implications for managers competing in the strategic setting. The Provision of Services under Two Settings Consider the following demand facing producers (1) Q(P,S) = S(A-P), where P is price, S is the per unit level of service provided in the market, and A is a shift parameter corresponding to the intercept on a linear demand curve. (1) According to (1), quantity demanded is inversely related to price and increases with the per unit level of service provided. Note, however, that since service is multiplied by the difference (A-P), demand does not shift parallel with an increase in service, but rather, rotates around the price axis. This is reasonable, since it suggests that the customer must purchase the good for service to have an effect on demand. …

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Charles Hegji

Papers

A Note on the Strategic Use of Service