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Competition in Prices and Service Level Guarantees

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  • Ramesh Johari

    ()
    (Management Science and Engineering, Stanford University Author-Workplace-Homepage: http://www.stanford.edu/dept/MSandE/)

  • Gabriel Weintraub

    ()
    (Columbia Business School)

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    Abstract

    In this paper we study the implications of service level guarantees (SLGs) in a model of oligopoly competition where providers compete to deliver a service to congestion-sensitive consumers. The SLG is a contractual obligation on the part of the service provider: regardless of how many customers subscribe, the firm is responsible for investing in infrastructure, capacity, or service quality so that the congestion experienced by all subscribers is equal to the SLG. First, we analyze a game where firms compete by setting prices and SLGs simultaneously. We establish that this game can be reduced to standard oligopoly models of price competition, greatly simplifying the analysis of this otherwise complex competitive scenario. Notably, we find that when costs in the original game are convex, the resulting equivalent pricing game also has convex costs. Further, for a broad class of models exhibiting constant returns to investment, the resulting pricing game is equivalent to a standard price game with constant marginal costs; many loss systems, such as those modeled by the Erlang loss formula, exhibit constant returns to investment. We then consider another commonly used contractual agreement between firms and customers: firms first set prices and investment levels simultaneously, and then consumers choose where to subscribe. In this case, firms provide the best possible service given their infrastructure, but without an explicit guarantee. Using the Nash equilibria of the games played by firms, we compare this competitive model with the model where firms set prices and SLGs, in terms of the resulting prices, service levels, firms' profits, and consumers' surplus.

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    File URL: http://www.netinst.org/Johari-Weintraub_07-21.pdf
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    Bibliographic Info

    Paper provided by NET Institute in its series Working Papers with number 07-21.

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    Length: 32 pages
    Date of creation: Sep 2007
    Date of revision: Sep 2007
    Handle: RePEc:net:wpaper:0721

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    Related research

    Keywords: competition; game theory; congestion; contracting; pricing.;

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    1. Xiao, Feng & Yang, Hai & Han, Deren, 2007. "Competition and efficiency of private toll roads," Transportation Research Part B: Methodological, Elsevier, vol. 41(3), pages 292-308, March.
    2. Nirvikar Singh & Xavier Vives, 1984. "Price and Quantity Competition in a Differentiated Duopoly," RAND Journal of Economics, The RAND Corporation, vol. 15(4), pages 546-554, Winter.
    3. GĂ©rard P. Cachon & Patrick T. Harker, 2002. "Competition and Outsourcing with Scale Economies," Management Science, INFORMS, vol. 48(10), pages 1314-1333, October.
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    7. Scotchmer, Suzanne, 1985. "Profit-maximizing clubs," Journal of Public Economics, Elsevier, vol. 27(1), pages 25-45, June.
    8. Nolan H. Miller & Amit I. Pazgal, 2006. "Budget or target: the choice between input and output strategies," RAND Journal of Economics, RAND Corporation, vol. 37(2), pages 391-415, 06.
    9. repec:rje:randje:v:37:y:2006:2:p:391-415 is not listed on IDEAS
    10. Kut C. So, 2000. "Price and Time Competition for Service Delivery," Manufacturing & Service Operations Management, INFORMS, vol. 2(4), pages 392-409, April.
    11. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
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