Intertemporal Price Discrimination and Investment in Brand Equity

We consider a firm that produces a specialty or a branded image good, where consumers derive part of their utility from the eliteness of the brand’s image and exclusivity of the product. Once high valuation consumers have purchased the product, it is optimal for the firm to reduce the price and capture lower valuation consumers. However, this dilutes the exclusivity of the brand, and results in a perceived loss to the high valuation consumers. In a two-period model, we show that if a firm is unable to credibly commit to not lowering the price in the second period, the first period price is adversely affected. We demonstrate that through a positive investment in brand equity that promotes the eliteness of the brand’s image, the firm can enhance the first period consumers’ utility from owning the product and thus offset their perceived loss in the second period. This higher utility encourages more consumers to buy the product in the first period, and mitigates the firm’s losses when the firm is unable to commit to a price path. More importantly, we show that an investment in brand equity is unlike an investment that enhances a tangible aspect of a product, in that, it substitutes for a firm’s ability to commit to a non-discriminatory price path. We establish this result by demonstrating that although a positive level of investment in brand equity is optimal irrespective of a firm’s ability to commit to a price path, the benefits from the investment are higher when the firm is unable to commit than when it is able to commit to a price path. JEL Classification: D91, D92, L11