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Competitive Strategies for Late Entry into a Market with a Dominant Brand Author(s): Gregory S.

Carpenter and Kent Nakamoto Source: Management Science, Vol. 36, No. 10, Focussed Issue on the State of the Art in Theory and Method in Strategy Research (Oct., 1990), pp. 1268-1278 Published by: INFORMS Stable URL: http://www.jstor.org/stable/2632665 . Accessed: 06/09/2013 12:25
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MANAGEMENT SCIENCE Vol. 36, No. 10, October 1990 Prinliedin U.S.A.

COMPETITIVE STRATEGIES FOR LATE ENTRY INTO A MARKET WITH A DOMINANT BRAND*
GREGORY S. CARPENTER AND KENT NAKAMOTO J. L. Kellogg Gradutate SchioolofManagement, Northwestern Universitv, Evanston, Illinois 60208 Karl Eller Graditate School of Management, Universitv oJfArizona, Tucson, Ari-ona 85721
This paper considers optimal positioning, advertising, and pricing strategiesfor a firm contemplating entry in a market dominated by an entrenchedcompetitor. Drawing on behavioralresearch on consumer preference formation, we develop an individual-level model that reflects differing consumer responses to similar products offered by the dominant brand and later entrants-an effect we term asymmetric preferences. From the resulting aggregatemarket response model, we derive several competitive implications, notably ( I ) that preference asymmetry can make a differentiated late entry strategy optimal even if preferences would appear to dictate otherwise, and (2) that me-too strategiesare not equilibrium late entry strategies.More generally,our analysis suggests that preference asymmetry can contribute to the persistent competitive advantage of dominant brands. (COMPETITION, LATE ENTRY STRATEGY, PREFERENCE ASYMMETRY, DOMINANT BRANDS)

1. Introduction Wrigley's chewing gum, Kleenex tissues, and other highly successful brands are formidable competitors. Because they are well known, widely distributed,and well positioned, these brands dominate their markets, retaining the largest share of their markets after many competitive entries, in some cases for decades (Urban, Carter,Gaskin, and Mucha 1986). While late entry can be successful (e.g., Pepsi in the cola market), devising successful strategies for introducing a new product into a market dominated by such a brand presents a difficult strategic problem. Analyses of new product introduction have drawn on psychometric methods such as multidimensional scaling to form the foundation for empirical studies (e.g., Urban and Hauser 1980; Wind 1982), while theoretical analyses have drawn heavily on game theory (e.g., Lane 1980), decision making under uncertainty (Schmalensee 1982), and the economics of industrial organization (Porter 1985). Despite this apparent diversity, all these approaches assume that product evaluation depends only on perceived or actual characteristics and price, not on the brand name with which a product is associated and the competitive context within which buyers must choose. For example, Schmalensee's (1982) analysis of the role of uncertainty in creating an advantage for pioneering brands ignores perceived differences among brands other than price and quality. A growing number of studies show that preferences and brand choice depend on a variety of contextual variables and constraints, including the composition of the set of competing alternatives (Huber, Payne, and Puto 1982) and the order of deliberations or agenda effect (Hauser 1986). These factors frame the choice process, affecting the relative importance of particular attributes and shifting the standards of comparison. Taking a dynamic view, Carpenter and Nakamoto (1987, 1989) examine the competitive advantage that can arise from a context effect induced by the order of consumer learning about products. In markets for multiattribute products and services for which
* Accepted by Diana L. Day, John U. Farley, and Jerry Wind.

1268 0025- 1909/90/36 10/1 268$0 1.25


Copyright ?B 1990, The Institute of Management Sciences

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the value of attributes is initially ambiguous, experiences with brands tried earlier lead to consumer preference structures favoring these brands. Moreover, they show that this preference formation process can create an asymmetry in preference between a dominant brand that is strongly associated with the category (e.g., Jello, Levi's, Federal Express) and others. A later entrant that positions close to the dominant brand with no distinctively different attributes or benefits is less preferred despite the similarity of its attributes to those of the dominant brand. This asymmetry would appear to make late entry a daunting proposition. Yet, late entrants often succeed, raising the central question considered in this paper: in a market with a dominant brand, what strategic options are available to a later entrant; which strategies are optimal, and when? We focus on a single late entrant competing in a two-dimensional perceptual space against a well-entrenched dominant brand using advertising and price. Recognizing differing buyer tastes and asymmetric brand evaluation, we develop models of market share and profit for both brands. We then ( 1 ) describe the options available to the late entrant associated with a high or low differentiationpositioning, and (2) identify optimal strategies for different competitive conditions. Our model is innovative in its construction, drawing its assumptions from empirical and experimental studies of brand choice and consumer behavior. This enables us to construct a game-theoretic model of late entry strategy that highlights the link between consumer behavior and competition. As a result, our analysis produces new substantiveinsights. Analyses based on traditional consumer models show that a later entrant positioning near the dominant brand will provoke ruinous price competition, making differentiatedlate entry optimal (Lane 1980). On the other hand, if there is initial uncertainty only about quality, Schmalensee ( 1982) shows that me-too strategies (lower-priced copies of the dominant brand) are required in order to gain trial. In our analysis, either a high or low differentiation positioning for the late entrant may be optimal depending on the extent of preference asymmetry. However, we show that low price strategies, such as me-too strategies, are not optimal. This is not because of ruinous price competition, but because of consumer preferences. Finally, the analysis suggests an alternative explanation for the persistent dominance of leading brands. Contrary to the prevailing view that competitive advantage arises from strategic investment in entry or mobility barriers (Porter 1985), preference asymmetry makes differentiated, high-priced entry optimal even if these entry barriers are absent. This provides an incentive for later entrants not to challenge the dominant brand directly, preserving its dominant position. 2. Consumer Choice and Brand Profit We focus on a mature market dominated by a single brand-the so-called dominant brand. The dominant brand is positioned in a multiattribute space and, at the mature stage of product life, buyers know its position as well as their preferences for product attributes. We explicitly exclude emerging categories for which preferences are still evolving, categories for which buyers have multiple or shifting ideals (due to variety seeking or multiple uses), and entry that alters the existing perceptual structure. We begin to develop an analytical framework with a model of utility for an individual as a function of brand positions, prices and advertising expenditures. From this, we derive an individual-level model of brand choice and, aggregatingacross individuals, a market response model that incorporates preference asymmetry. We then model brand profit based on this response structure and derive, subject to the specified rules of competition, optimal late entry strategies.

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2. 1. Buyer Utility Consider a ouyer with ideal point I = (x*, y*) located in a two-dimensional space. The utility of either the incumbent or the later entrant can be summarized as
uii = vi(sih, S12,

ai, pi) + ei,

(1)

where ui is the overall utility of brand i; vi is the deterministic component which depends on sij, the perceived similarity of brand i to I; Sl2, the perceived similarity of the two brands, ai and pi, brand i's advertising and price respectively; and ei, a random utility component capturing idiosyncratic elements of utility. Utility functions of this general form are common in both models of brand choice (e.g., Carpenter and Lehmann 1985; McFadden 1986), and in analysis of spatial competition and brand positioning (e.g., Carpenter 1989; de Palma et al. 1985). The impact of positioning on utility is captured in equation (1) by the two measures of perceived similarity, si1 and sl2. The impact of the first of these is rather intuitive and consistent with most preference models: the greater the perceived similarity of a brand (either the dominant brand or the later entrant) with the buyer's ideal, all else equal, the greater the relative preference for that brand (avil/si, ? 0, i = 1, 2). For example, Figure 1 shows two alternative positions for the later entrant (Brand 2), equally similar to Brand 1 (the dominant brand). Brand 2' will be more highly valued by buyers than Brand 2, because Brand 2' is closer to the buyer's ideal point. The impact of perceived similarity between brands on utility, however, varies by brand to reflect the preference asymmetry favoring the incumbent (Carpenter and Nakamoto 1987, 1989). For the incumbent, increasing similarity to the later entrant increases utility, all else equal (i.e., aVM/0S12 ? 0). For the later entrant, brand utility decreases as perceived similarity with the incumbent increases, again other things equal (i.e., aV2/0s12 < 0). This asymmetry characterizes our notion of brand dominance, in that greater similarity between the two brands leads to greater valuation of the dominant brand and a lesser evaluation of the later entrant. This is illustrated in Figure 2. The behavioral motivation for this assumption is that dominant brands enjoy a perceptual distinctiveness in the category that allows them to overshadow similar competitors (c.f. Barsalou 1985; Smith and Medin 1981). Advertising plays two roles in this formulation. Along with product features,advertising positions brands, determining si, and s12. We referto this as positioning advertising. Once brands are positioned, the images are maintained by maintenance advertising, denoted

Brand 2' *. Ideal Point * Brand 1


* Brand 2

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y
* Brand 2 'Ideal Brand 2'. * Brand 1 Point

x
FIGURE 2.

Alternative Positions for a Later Entrant Equidistant from the Ideal Point.

by ai is equation (1). Maintenance advertising directly affects brand evaluation (Ray 1982); greater expenditures increase brand evaluation, all else equal (i.e., avil/ai ? 0, i = 1, 2). Prices affect brand evaluation in the expected manner (avil/pi < 0, i = 1, 2), though buyers are less price sensitive in markets where a dominant brand has been followed by no immediate rivals and subsequently become entrenched (Carpenter and Nakamoto 1989). 2.2. Brand Choice and Market Share Buyers choose either the incumbent or the later entrant to maximize utility. Thus, for an individual with ideal point I, the probability that brand i is chosen is mi1(s1, a,p)
where s1 =
(SII, S2I, S12), =

Prob(Ui> tij), i
=

1,2,

i#j,

(2)

(a,, a2), p

(PI,P2),

and Prob( *) is a probability function.

The choice probability, in, is also the market share of brand i among individuals with ideal point I. The market share of brand i among all Q buyers is mi1weighted by the distribution of ideal points, f(I). More formally,

mi = fnmii(s,

a, p) f(I) dI, i = 1, 2,

(3)

where mi is the market share of brand i, and where ml + M2 = 1. The actual shares, obviously, depend on the shape off( I), the taste distribution. We restrict our analysis of unimodal and symmetric taste distributions, like the ones shown in Figure 3. Unimodality, which allows for variation in taste, simply implies that one attribute combination is preferred by more consumers than any other. We refer to this as simply the ideal point and denote it by I*. Symmetry, a simplifying assumption, implies that there are circles of equal numbers of consumers' ideal points surrounding *. We place no other restrictionson the taste distribution, notably on how much variation in tastes exists. Under these restrictions, it can be shown that mi depends on the perceived similarity of brand i to the ideal point, the perceived similarity between brands, and both brands' advertising and prices. Therefore, we can write
min= m1(s, a, p), where s
=

(s1, s2, s12),

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fi(I)

GREGORY S. CARPENTER AND KENT NAKAMOTO


f (M)

4N~~~~~
FIGURE 3.

Two Symmetric, Unimodal Distributions of Consumer Ideal Points.

si being the similarity of brand i to J*. In this formulation, positioning, advertising, and price affect brands' relative attractiveness and thus market shares, even though the overall size of the market is Q units. 2.3. Brand Profit To construct a model of brand profit from which analytical rather than numerical solutions can be obtained, we approximate the market share function using Kolmogorov's Theorem: mi(s, a, p)
=nil (si) + MiA2(s) + M'n3(s12) + mi4(ai)

+ 01i5(ai) + mi6(pP) + Mni7(pi),i,j

1, 2; i #j,

(4)

? 0, Mn,2 < 0, M113 2 0, M123 < 0, Ml14 ? 0, Mi15 ? 0, m,6< 0, Ml7 > 0. where m*,] Kolmogorov has shown that a multivariate function such as mi, can always be best approximated (in the sense that Mni globally minimizes sup Imi i I) by a sum of univariate functions (Cheney 1983; Lorentz 1966). For comparable approaches, see Carpenter (1989), and Hauser and Shugan (1983). See Simon (1982a, 1982b) for empirical analyses using market response models of the general form of equation (4). Based on this additive approximation, profits for brand i are

Hi = Q(pi - ci)mi(s,

a, p) - ai, i

1, 2,

(5)

where ci are unit costs. In addition, Hi is assumed to be concave. 2.4. Competition The incumbent and the later entrant compete in two stages to maximize profits. First, the later entrant positions its brand through a one-time outlay of positioning advertising, anticipating the equilibrium strategies and profits that will follow. Second, subject to both brand positions, both brands simultaneously select optimal competitive (Nash equilibrium) maintenance advertising expenditures and prices. Sequential decision processes, typical of formal models of spatial competition (e.g., Carpenter 1989; de Palma et al. 1985; Hauser 1988), and are reasonable if pricing and advertising decisions are made based on product designs (Urban and Hauser 1980; Wind 1982).

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3. Optimal Competitive Pricing and Advertising In stage-two competition both brands select advertisingand price levels, given positions, to maximize profits. More formally, for a given similarity vector, s = (SI, s2, S12), both brands select an optimal advertising expense and price, a* = (a*, a*) and p* = (p*, P2 ), that satisfies flj/Oaj= OHj/pj = 0, i= 1, 2. We analyze the impact of positioning on optimal competitive advertising and pricing by considering the effect of varying ( 1 ) the similarity between the later entrant and the ideal point, (2) the similarity between brands, and (3) both perceived similarity measures simultaneously. 3. 1. Similarity to the Ideal Point The later entrant's perceived distance from the ideal point affects both brands'strategies for pricing and advertising, holding fixed the perceived similarity of the brands.
PROPOSITION 1. The closer the later entrant is perceived to be to the ideal point, the higher its optimal competitive price and advertising expenditturesand, holding fixed the perceived similarity of the brands, the lower the dominant brands's optimal competitive advertising expenditure and price.

Positioned far from the ideal point, later entrants often underprice and underspend the dominant brand, e.g., C&C Cola. If the later entrant is closer to the ideal point, differences in advertising spending and pricing tend to be smaller, as in the competition between Coke and Pepsi. Proposition 1 is also consistent with results from models in which preferenceasymmetry is not an issue (e.g., Carpenter 1989; Lane 1980). suggesting that preference asymmetry does not affect these relationships. 3.2. Similarity to Dominant Brancd The preferenceasymmetry does affectthe impact of perceived similaritybetween brands on advertising and pricing:
PROPOSITION 2. As the perceived similarity between brancds incrteases,the later entrant's optimal competitive advertising expenditures and price both decrease, whereas the brand's optimal comnpetitive domninant advertising spending and price increase, holding the distance Qfboth from the ideal point fixed.

Proposition 2 shows that asyvnmetric preferences produce as.vnwnetricdifferences in advertising spending and prices in response to differences in perceived similarity between brands. The later entrant must cut price and advertising spending whereas the dominant brand faces no such pressure as seen in the proliferation of lower priced, little advertised brands that frequently cluster around a dominant brand (Urban et al. 1986). 3.3. High VersitsLow2 Differentiation in Late EntrY Propositions 1 and 2 reveal two opposing forces driving advertising spending and prices. Drawing closer to the ideal point (Figure 4), the later entrant'sadvertisingspending and price should rise (Proposition 1), but simultaneously drawingcloser to the incumbent, advertising spending and price should fall (Proposition 2). However, we can derive conditions under which certain advertising and price levels are optimal, given the level of differentiation adopted by the late entrant. We define the asvmmetric competitive advantage of the dominant brand as m2I + M'23. Recall that iS the marginal share benefit for Brand 2 of moving closer to the ideal point, mn21 (?0)

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y Brand 2

Brand 2-

* Ideal * Brand 1

Point

K FIGURE 4.

Low Differentiation (Brand 2) and High Differentiation (Brand 2') Positions for a Later Entrant.

and M23 (?0) is the marginal share cost for the later entrant of moving closer to the incumbent, i.e., m23 represents the impact of the preference asymmetry on the market share of Brand 2. When m21 + m'23is negative, there is a net cost to the later entrant of being close to the dominant brand, reflectingits strong asymmetric competitive advantage. Conversely, we term the dominant brand's asymmetric competitive advantage weak when m'21+ m 3 is positive.
PROPOSITION 3. If the asymmetric competitive advantage for the dominant brand is strong, then the less differentiated the second entrant, the lower its advertising spending and price shouildbe. If the asymmetric competitive advantage of the dominant brand is weak, then the less differentiated the position of the second entrant, the higher both its advertising spending and its price shoulldbe.

Proposition 3 defines four potentially optimal combinations of positioning, advertising spending, and price, based on high or low differentiation positions for the later entrant and strong or weak asymmetric competitive advantage for the dominant brand (see Figure 5 ). There are two low differentiation strategies- challenger (with high advertising and price), and me-too (with low advertising and price). Pepsi's repositioning in the Differentiation of Late Entrant High Differentiated Strong Asymmetric Competitive Advantage of Dominant Brand Weak
High Advertising High Price

Low Me-Too
Low Advertising Low Price

Fringe
Low Advertising LowPrice

Challenger
High Advertising High Price

FIGURE 5.

Optimal Advertising and Price Policies for Late Entry Given Position of the Later Entrant.

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mid- 1970's head-to-head with the dominant brand in the cola market, Coca-Cola, precipitating the so-called cola wars, exemplifies the challenger strategy (Kotler 1988). On the other hand, Purex bleach's positioning as a lower cost, less advertised alternative to Clorox represents a me-too strategy. There are likewise two high differentiation strategies, which we term a differentiated strategy(accompanied by high advertising spending and high price), and afringe strategy (accompanied by low advertising and price). Honda's original entry into the U.S. motorcycle market with a smaller displacement engine to compete with the larger HarleyDavidson, long the industry leader, illustrates a differentiated strategy. In- contrast, a fringe strategy might be represented by Rent-a-Wreck in the auto rental industry, which is clearly differentiated from Hertz and competes with a low advertising budget and low relative prices. 4. Optimal Competitive Positioning To establish the profitability of each of the four strategies, we consider stage-one competition in which the later entrant picks a product position, anticipating the equilibrium advertising expenditures and prices that will result. We analyze how profits depend on the proximity of a brand to the ideal point, similarity to its competitor, and finally, both. Using these results, we derive the conditions under which each strategy is optimal; more formally termed a subgame-perfect Nash equilibrium (Friedman 1977). 4. 1. Similarity to the Ideal Point Profits for the later entrant depend on the market share generated from its position, the optimal advertising spending and price implied by that position, and the reaction of the incumbent. Moving closer to the ideal point increases the late entrant's optimal advertising spending and price. But the incumbent's optimal reaction includes cutting price and advertising spending (Proposition 1). Reduced advertising spending by the dominant brand will clearly benefit the late entrant, but falling prices will not. Still, the net result is unambiguous:
PROPOSITION 4. Profits,for the later entrant increase as its perceived similarity to the ideal point increases, holding constant the perceived similarity between brands.

Proposition 4 supports an assumption implicit in many models of new product positioning-being closer to the ideal point is more profitable (e.g., Urban and Hauser 1980). However, this is assured only holding fixed the perceived similarity of the new entrant and the dominant brand. 4.2. Similarity to the Dominant Brand Changing the perceived similarity of the later entrant and incumbent also has multiple effects. Greater perceived similarity between brands lowers the optimal advertising and price of the later entrant but increases the advertising spending and price of the dominant brand (Proposition 2). A higher price for the dominant brand boosts the profits of the later entrant, but the higher advertisingspending reduces the later entrant's share, hurting its profits. Again, however, the overall impact is unambiguous:
PROPOSITION 5. Greater perceived similarity of the later entrant to the incuimbent reduicesprofits of the later entrant, holding fixed the similarity of the brands to the ideal point.

Proposition 5 identifies the cost of undifferentiated late entry. Because of preference asymmetry, an undifferentiated position is associated with low relative advertising spend-

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ing and low relative price, which translate directly into small market share and low profit. In other words, preference asymmetry can make undifferentiatedlate entry unattractive. 4.3. EqutilibriumLate Entry Positions Given Propositions 4 and 5, neither of two positions-similar to the dominant brand or differentiated from it-guarantees higher profit under all conditions. However, we can specify the superior position and the associated optimal advertising spending and price, contingent on the magnitude of the asymmetric competitive advantage of the dominant brand.
PROPOSITION6. If the dominant brand enjoys a strong asymmetric competitive advantage, a differentiatedstrategy is optimal. If the asymmetric competitive advantage of the dominant brand is weak, a challenger strategy is optimiial.

Proposition 6 shows that, of our four strategies, either a challenger or differentiated strategy is optimal, and the condition specifying which is optimal is the same as that for Proposition 3. Thus, when the dominant brand's advantage is weak, we know from Proposition 3 that a challenger strategydominates a me-too strategy,and a fringe strategy dominates a differentiated strategy. Proposition 6 shows further that, in this case, the challengerstrategyyields more profit than a fringe strategy.Because of a smaller preference asymmetry, profits increase most as the later entrant positions near the ideal point, even if that means direct competition with the dominant brand. Conversely, when the dominant brand's advantage is strong, Proposition 3 holds that either the me-too or differentiated strategy is optimal. Here, Proposition 6 indicates that the differentiated strategy yields more profit than the me-too strategy. Because of the preference asymmetry, the cost of positioning near the dominant brand exceeds the benefit of being perceived as similar to the ideal point. These implications are summarized in Figure 6. 5. Implications Our analysis suggests that differentiatingwith a high advertising budget and high price is optimal if the dominant brand has a powerful asymmetric competitive advantage. This is true even if the distribution of consumer tastes would appear to suggest otherwise. The asymmetry means that any gain in market share from moving closer to the ideal point Differentiation of Late Entrant High Low

Strong Asymmetric Competitive Advantage of Dominant Brand

Differentiated

Weak

Challenger

FIGURE 6.

Optimal Entry Strategies for the Later Entrant.

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will be more than offset by loss due to being closer to the dominant brand. As a result, profits of the later entrant increase with brand differentiation. Absent a strong asymmetric competitive advantage, directly challenging the dominant brand with a high advertising budget and high price is optimal. A leading brand without asymmetric preference structure is not well protected from competition. Later entrants can gain more in market share and profit by positioning close to the ideal point than they can lose by being less differentiated. This result is consistent with the logic of marketing models of new product introductions and the results of game-theoretic analyses of sequential entry (e.g., Wind 1982; Lane 1980). Challengerstrategiescan be enormously successful as in the cases of Pepsi, Avis, and Yamaha (Kotler 1988). An important consequence of our analysis is expected relatively poor performance of me-too products, as observed by Urban et al. ( 1986). In our analysis, me-too strategies do not necessarily fail, but they are not optimal. Positioning near the dominant brand can lead to price cutting by the later entrant, but a severe price war need not follow (as suggested in models of sequential entry). If the brand persists in pursuing a me-too strategy, it may simply be a perennial "also-run" in terms of profits. Even so, fringe and me-too strategies should not be ignored completely. They clearly require smaller budgets than either challenging the dominant brand or differentiating from it, albeit with smaller rewards.In addition, if the development cost of a differentiated product or the positioning cost of an undifferentiated product are high, these costs, when balanced against the revenue implications of our analysis, might make these strategies more attractive. These implications are consistent with practitioner experience. We conducted an exploratory survey of 60 middle-level marketing and sales executives after respondents were exposed to the core concepts presented here in a two-hour session devoted to entry and defensive marketing strategies. The mean rating of the importance and relevance of the concepts, on a scale of 1 (utmost importance) to 5 (not important at all), was 1.5 1. In addition, qualitative assessments collected from 23 respondents were strongly supportive, including anecdotes consistent with our results in a number of industries. Though more rigorous study is needed to test the range of applicability of our results, these preliminary findings are encouraging. Finally, our results suggest a competitive process in markets with a dominant brand that differ significantly from one where all brands are playing on a level field. Rather than "excess" profits attracting entry and price competition, thus producing fair market returns for all firms, asymmetric preferences can create competition in which a dominant brand may attractentry, but that entry places little downward pressureon the incumbent's profits. This preserves rather than eliminates the incumbent's competitive advantage. In short, asymmetries in consumer preference can be a source of persistent competitive advantage.'
' This research was supported in part by a grant fiom the Marketing Science Institute and faculty research grants from Columbia University and the University of Arizona. An extended version of this paper, including Appendix with proofs of the propositions, is available from the authors.

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