Bidimensional vertical differentiation☆

a r t i c l e i n f o In markets where product quality is important, more than one characteristic is usually necessary for producers to define product quality. Standard theory maintains that: (i) in a duopoly there will be a quality leader no matter whether the product can incorporate one or two vertical attributes; (ii) differentiation pertains only to one attribute. By contrast, in our setup , there are also equilibria where the quality leader is better in two attributes, and others where there is cross leadership, namely a situation where each firm designs a product to dominate the other in one characteristic. Applications to Minimum Quality Standards and tax (subsidy) on quality products are sketched, showing spill-over effects from one to the other quality dimension. Firms seeking to differentiate their products from those offered by rivals devote considerable efforts to avoid defects, improve performance , ameliorate components and embellish the design. The term 'quality' is often used to group the result of all these activities under a single concept, referring to a set of measurable attributes which, if increased, lifts consumers' satisfaction. Hence quality is in effect multi-dimensional. However, the literature formalizing the analysis of oligop-olistic competition in quality is shaped upon the Gabszewicz and Thisse (1979) and Shaked and Sutton (1982, 1983) basic framework with two firms and one quality dimension, which forms the skeleton for today's thinking about price and quality competition under vertical product differentiation. The best known result, there, is that two firms will differentiate their quality levels, possibly as much as they can, with one firm choosing the lowest possible quality — a result to be contrasted with the ('horizontal') Hotelling's (1929) Principle of Minimum Differentiation. In later works, it has been shown that if two quality dimensions define a product specification, only one of them will be used to differentiate, and the other will be equal across firms This, at least in part, justifies the frequent adoption of a model with a single quality dimension. According to the standard unidimensional theory, therefore, under vertical differentiation one should expect that (i) quality leaders emerge among firms, while followers sell goods of inferior quality; (ii) quality leadership should be expressed by a difference in just one vertical attribute. 1 This description, however, seems only partially appropriate to the different patterns observable in many markets, and hence it cannot exhaust the industry configurations …