Service and price competition in a variety seeking market

We study service and pricing competition in a duopoly market where consumers are variety seeking, which is modeled as a decrease in the willingness to pay for the product purchased on the previous purchase occasion. Under a two-stage Hotelling-type model, we show that the presence of variety seeking consumers induces higher service levels in Period 2, if prices are committed at the beginning. The higher service in Period 2 represents the incentive that firms need to offer to prevent the variety seeking consumers from switching. Furthermore, if consumers on average have a higher propensity to one firm, the variety seeking behavior increases both the price and service gaps, thus to exaggerate market differentiation. In addition, variety seeking leads to higher total profits and a higher consumer surplus.