Reform in a Differentiated-Product Industry: The Case of the Korean Cigarette Manufacturing Industry

This paper explores the ramifications of privatization and deregulation in a differentiated-product industry. The analysis focuses on the change in firms’ product portfolio and pricing policy. Using product-level data on the Korean cigarette manufacturing industry, which underwent major reform recently, a random-coefficient discrete choice model is estimated to approximate substitution patterns among cigarette products. The findings are as follows. First, in the post-reform period, new products are significantly less price-elastic than existing ones; however, no such relationship is found in the pre-reform period. Second, data in the pre-reform period is not consistent with firm-level profit maximization mainly due to the failure to internalize within-firm substitution. In the post-reform period, however, partial evidence supports the view that pricing of new products is compatible with firm-level profit maximization. Overall, the analysis suggests that firm efficiency improves in the post-reform period through the introduction of profitable products and the proper pricing of these products.