Implications of Market Spillovers

In recent years, several firms have decided to withdraw from profitable markets, believing the move will be beneficial for their overall business. For instance, CVS dropped tobacco products from its shelves in 2014, while Aldi dropped confectionery from its checkout lines in 2016. Findings from consumers’ evaluation of such moves suggest there exists a negative market spillover from selling in a market, such that a firm’s participation in one market reduces consumers’ willingness to pay for the firm’s products in other markets. On the other hand, certain socially favorable markets, such as markets for environment-friendly products, have been shown to create a positive market spillover for their sellers, increasing consumers’ willingness to pay in other markets the sellers participate in. We build an analytical model of two competing firms to examine how firms react to a market spillover and find the conditions under which different firms would sell in the spillover-producing market. Our analysis of how firms’ profits are affected by market spillovers identifies the consumers’ reservation value in the spillover-producing market, the relative size of the two markets, and the extent of the market spillover as key factors determining which firms benefit from a market spillover. Interestingly, we find it is possible for both firms to make more profit with a negative market spillover compared to when there is no market spillover, while a positive market spillover can actually result in lower profits for both firms compared to no market spillover.