Performing Department
Morrison School of Management and Agribusiness
Non Technical Summary
Developing and marketing innovative food products is essential to keep up with changing consumer tastes, sustain international competitiveness, and improve the efficiency of the agricultural marketing system. While there is large amount of research on the value of new products, there is little on key strategic problems faced by innovating firms: how to price and design new food products subject to social network, or interpersonal demand effects. The primary objective of the proposed research is to describe equilibrium pricing and design strategies in a multi-product, differentiated-product, vertical market characterized by social network effects. We use an explicitly spatial model in which manufacturers choose both the price and location in attribute space in a two-stage game-theoretic framework. Both stages are subject to indirect network effects through the interaction of individual demands. We estimate the model using experimental choice data on a hypothetical new breakfast cereal. The empirical model of demand explicitly considers each product's unique location in attribute space, and uses these results to simulate pricing and product design. Our results will provide stakeholders with critical insights into how pricing and design decisions are influenced by social network effects.
Animal Health Component
50%
Research Effort Categories
Basic
50%
Applied
50%
Developmental
(N/A)
Goals / Objectives
The primary objective of the proposed research is to estimate equilibrium pricing and design strategies for new food products in a multi-product, differentiated-product market characterized by social network effects. By allowing for the effect of human interaction on the demand for a hypothetical new food product, we apply the behavioral economics paradigm to innovation in food supply networks for the first time. In order to achieve these objectives, in the proposed research, we will first construct a theoretical model of equilibrium price and attribute-design (location in attribute space) for differentiated food products sold in a differentiated-products oligopoly retail market. Second, we will specify a structural (demand and supply) econometric model of new food product demand, incorporating explicit definitions of social and attribute space, and estimate the model using spatial econometric methods. Our third objective is to design and implement a social network analysis experiment in order to generate willingness-to-pay data from a realistic test-bed environment for a series of new food products that differ in terms of their price and location in attribute space. Fourth, we will estimate the econometric model using the data generated from the social network analysis / choice experiment. With these results, our fifth objective is to conduct welfare simulations on the economic value (consumer surplus plus producer surplus) of the equilibrium pricing, design and social network effects described in this research. As a sixth objective, we also seek to estimate the effect of demographic and socioeconomic attributes on equilibrium pricing, product design and social network effects in the development of local and other value-added food products. Finally, our seventh objective is to develop and recommend business and government strategies that will aid in the successful development and commercialization of value-added food products using the insights and methods developed in this research. In terms of expected results, we believe that successful achievement of these objectives will generate significant advances in: (1) the theoretical industrial organization literature on equilibrium price and product location, (2) the empirical literature on estimating price and location games, and (3) the social network literature on applications to the economics of product innovation. On a practical level, USDA, state departments of agriculture and emerging agribusinesses responsible for either designing and marketing new food products, or helping others to do so, will be better armed to make effective decisions with our research. Further, managers need to understand the role social networks can play in helping their product gain market share, and how they can use their marketing resources to exploit any social networks they may have access to.
Project Methods
The analysis will consist of five stages: (1) development of economic and econometric models of equilibrium product design and pricing, (2) extend econometric model to include social network effects, (3) social network / product valuation experiment design and implementation, (4) econometric estimation, testing and simulation, and (5) results interpretation, report generation and dissemination. Our approach in the first stage is based on a structural model of a frequently-purchased consumer food market (breakfast cereal) in which we endogenize the equilibrium choice of both price and attribute design. By structural model, we mean that the primitives consist of a model of demand estimated at the consumer-level, a model of supply that is based on first order conditions to a Bertrand-Nash choice of firm-level optimal price and product design, and a distance-metric measure of product differentiation. The econometric model consists of a discrete choice, random utility model of differentiated product demand (Anderson, de Palma and Thisse, 1992). While mixed-logit models account for consumer heterogeneity and product differentiation by allowing for correlation among consumer-specific response parameters, we adopt a more explicit approach by directly measuring the distance between individuals and products in attribute space and estimating the model using spatial econometric methods (LeSage 1998; Pinkse and Slade, 2004; Slade, 2004; Richards, Hamilton and Patterson, 2007). This distance metric (DM) approach represents both a more intuitive way to describe the location of products in attribute space, and a more useful means of generating econometric results that growers can use in developing new products. In the second stage, we extend the DM / discrete choice model to include social network effects. This extension is a natural and relatively straightforward extension of the DM approach because the model already includes a distance matrix in attribute space - we simply add another that represents the distances among our experimental subjects that we collect in the third stage of the study. Once the demand estimates are in place, we estimate the supply-side of the model. Assuming Bertrand-Nash competition among manufacturers in prices and product location, we estimate strategic response parameters derived from the solution of a game-theoretic model of firm rivalry. In the fourth stage, we simulate the implied changes in consumer welfare from introducing a new, hypothetical food product with attributes that place it within the existing attribute space. By comparing simulation results between outcomes with the social network effects included with those where we assume no social network effects, we can derive the economic importance of leveraging space both in an attribute and social context.