Competition and Contracting in Service Industries

Ramesh Johari, Gabriel Y. Weintraub
2008 Social Science Research Network  
In service industries with congestion effects, two very different contractual structures are commonly observed, depending on whether or not firms choose to offer a guaranteed service level. We analyze the impact of these choices on market outcomes in oligopolistic industries, with a particular focus on models inspired by modern technology-based services, such as telecommunications and computing services, that exhibit constant returns to investment. We present a multistage model in which firms
more » ... el in which firms first choose whether or not to offer service level guarantees, and then competitively offer contracts of the type they have chosen. We study this competitive setting through the Nash equilibrium (NE) of the game played by firms. Broadly speaking, our results suggest that competition is intensified when firms choose to offer service level guarantees. In particular, a game in which all firms offer service level guarantees yields a more competitive NE with lower prices, compared to the NE of a game in which all firms set an investment level and no explicit guarantees are offered. Moreover, the analysis of the full multi-stage game suggests that, under most circumstances, not committing to a service level is a weakly dominant strategy for firms. Our results highlight how different contractual agreements change the intensity of price competition in service industries, yielding insight into business and policy considerations.
doi:10.2139/ssrn.1087450 fatcat:46bo4odm5vdplmrejf4wdxomvi