Quality discrimination across markets and the strategic implications of government regulation

Faculty Development Competitive Research Grants 2020-2022

When a multinational firm enters a new market, it typically wants to adjust its product attributes to better match the specific conditions in the new market. For example, if the firm enters a low-wealth country, it would tend to decrease its product quality to be able to charge a lower price. Hence, the firm would not only price discriminate between the markets, but also quality discriminate. One such firm is Leibniz, a leading German producer of biscuits. It was found that in Germany Leibniz biscuits contain 12% butter and no palm oil, while in Poland the same biscuits contain only 5% butter and also some palm oil, which is a cheap substitute for butter. In Hungary, the food safety agency examined a range of brands sold in both Hungary and Austria, and it found that the Hungarian versions of some products were inferior to the ones sold in Austria. The variance of a firm’s product quality across different markets has generated significant discontent in some countries. To address the issue, the EU Commissioner for Justice, Consumers and Gender Equality said that,
“Dual quality of food products of the same brand in the member states is misleading, intolerable and unfair to consumers. I will do my best to stop it.”
In addition, surveys conducted among consumers showed that consumers do not like quality differences across countries (http://www.reuters.com/article/centraleurope-food/east-europeans-decry-double-standards-for-food-seek-change-to-eu-law-idUSL5N1GD4N4).
In response to quality differences between markets, many consumers have started purchasing certain brands from resellers who originally bought the product from a neighboring country and imported it to the home country for resale. Hence, the variation in the same product brand’s quality across different countries has led to the creation of a gray market, because individual entrepreneurs started purchasing the product in one country and reselling it in another country, circumventing the official channel through which the brand is sold.

The above observations have motivated several interesting and novel research questions. The first group of research questions is related to the situation where the firm is free to offer different product qualities in different markets, and we study the effect of gray markets on the firm’s strategic decisions on product pricing and quality. For example, will the existence of the gray market lead to lower quality and price differences between the markets? The second group of research questions is related to the government’s policy decision on whether to impose a requirement on the firm to offer uniform product quality across different markets. This is in line with proposed policies in the European Union which would require from the firms to provide uniform product qualities across the EU market. Note that studying the first group of questions is necessary to be able to make a correct policy decision on whether to impose a uniform product quality requirement—without knowing the firms’ incentives in the absence of a uniform quality requirement, the government cannot correctly evaluate the impact of introducing such a requirement.