The role of brand image and product characteristics on firms' entry and OEM decisions

Abstract

We investigate the optimal market entry and original equipment manufacturer (OEM) decisions of a firm facing a market in which firms' brands can be horizontally differentiated and products can be vertically differentiated. The entrant might sell under its own brand and compete with an incumbent, become a supplier to the incumbent, or both. Findings reveal that when consumers perceive the firms are horizontally and vertically differentiated, the entrant profits by simultaneously entering the market and establishing an OEM arrangement with the incumbent. In such competitive scenarios, both buyer and seller increase profits by agreeing on wholesale prices that are not too low, which softens both horizontal and vertical conflict between the firms. Findings also show that the incumbent may prefer to pay high wholesale prices to the entrant even if the incumbent had the option to source the product independently at a lower marginal cost. When firms have the capability of producing each other's product lines, supply relationships between them can still happen in equilibrium. In this case, an interesting result is that firms may optimally select to differentiate production and, because of the OEM relationship, sell the same product qualities to consumers. The reason for this outcome is that the OEM arrangement with differentiated production causes a strategic effect that reduces the firms' aggressiveness when competing for consumers. Under certain conditions, the OEM arrangement can completely nullify the horizontal and vertical conflict between the firms.