Cost Leadership and Pricing

Economics Letters, August 2001

Rajeev K. Tyagi

Abstract

It is sometimes argued that cost leaders compete in markets primarily by charging prices lower than their competitors (e.g., Porter 1985). This paper points out that this belief relies crucially on the assumption that firms compete on vertically-differentiable product characteristics alone. We show that if firms (i) compete instead on horizontally-differentiable product characteristics alone, and (ii) choose their product positions simultaneously before competing on prices, then the cost leader always charges a price higher than its competitor. Thus, this paper points out that whether we expect a cost leader in a market to charge a price lower than its competitors depends on the relative importance of horizontal versus vertical differentiation in that market.

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