Shogo Kurokawa and Nobuo Matsubayashi

In this study, we investigate price and quality decisions in a duopoly in the presence of firms’ quality positions, which are determined by the quality levels of their existing core products. Into a standard model of vertical differentiation, we incorporate a “repositioning cost” that is proportional to the quality differences between firms’ current and new products. By varying the levels of quality positions, we analyze the impact of this cost on the equilibrium outcomes. Our results show that the presence of repositioning costs restricts firms’ abilities to improve profitability and differentiate themselves vertically. As a result, a high-positioned firm does not necessarily have a competitive advantage over a low-positioned firm, even if the former offers a superior new product in equilibrium. In addition, if a low-positioned firm is significantly cost-efficient compared with its rival with regard to repositioning, then that firm can earn higher profits than those of a high-positioned firm by strategically offering its low-end product. These results contrast sharply with those based on the standard vertical differentiation model.