Optimal prices, package sizes and package compositions in a market with variety seeking and loyal consumers

In this paper we analyze how the presence of loyal versus variety seeking consumers affects manufacturers’ package decisions. Package decisions relate to the price of the package, the quantity of the commodity it contains, and the number of different varieties in it. We first study the optimal consumption of packages by the two types of consumers, taking into account their purchasing, transaction and inventory cost. We then derive market equilibria in the monopoly and in the duopoly case. Depending on the variety seekers’ brand switching tendency, and on the quality difference between firms, the resulting duopoly Nash equilibrium is (1) a ‘driving out’ equilibrium in which one firm is able to deter entry by another firm, or (2) a ‘market sharing’ equilibrium in which the two firms share the market of variety seeking consumers. In either case, selling different package sizes/compositions is shown to be a profitable price discrimination mechanism, allowing the manufacturer to exploit differences in package preferences and willingness to pay between loyals and variety seekers. The model provides a rationale for package size and composition strategies observed in practice, and indicates when quantity discounts or surcharges are likely to prevail.