Promotion, Brand Awareness, and Price Competition in Large Online Markets

We study a model where retailers endogenously engage in both promotional advertising to attract loyal customers as well as informational advertising, which consists of deciding whether and what price to list on a price comparison site. We derive a symmetric subgame perfect equilibrium of the model and study the limiting properties of equilibrium prices, promotion, and listing decisions as the number of competitors grow large. In equilibrium, firms choose positive promotion levels, thereby creating loyal customers, but competition in this dimension ultimately reduces firm and industry profits. We show that prices do not converge, regardless of the number of competing e-retailers. As a consequence, the model predicts persistent price dispersion online regardless of the number of competing firms. Finally, we show that this price dispersion persists even when it is prohibitively costly for firms to create loyal customers. A key testable prediction of our analysis is that the observed levels of price dispersion (measured by the range) will differ systematically across markets with different costs of creating loyal customers.