The Role of Brand Image and Product Characteristics on Firms' Entry and OEM Decisions

This paper shows that differences in brand image and product quality (horizontal and vertical differentiation) can govern the market-entry decisions of firms facing a market already served by an incumbent. The entrant might sell under its own brand, become a supplier to the incumbent (called an OEM arrangement), or both. Findings reveal that when firms are vertically but not horizontally differentiated, the entrant cannot profit from entering the market on its own, but firms can profit from OEM arrangements. When firms are both vertically and horizontally differentiated, the entrant profits by simultaneously entering the market and establishing an OEM arrangement with the incumbent. This is an interesting outcome because in competitive scenarios in which firms compete for consumers, the entrant will effectively sell its own product to the competitor. Furthermore, in those competitive scenarios, both buyer and seller increase profits by agreeing on a high wholesale price. When firms have the capability of producing all possible qualities of the products on their own, OEM relationships between firms can still happen in equilibrium. In this case, the most interesting result is the fact that, under certain conditions, firms may select to produce goods of different qualities and become suppliers to each other, despite the fact that they will end up selling the same product qualities to consumers. The reason for this outcome is that this dual buyer-seller arrangement causes a strategic effect that reduces the firms’ aggressiveness when competing for consumers.