Strategic choices of quality, differentiation and pricing in financial services

Two financial services firms (FSFs) produce information on future returns f rom risky assets, incorporate this information in a report and sell the rep orts to investors. The FSFs make strategic choices of the quality, differen tiation and prices of their reports. Their optimal strategic choices of qua lity and differentiation divide the market for the report into three segmen ts. Each FSF has a monopoly in its own segment, and the two compete head-to -head in a duopoly segment. The sizes of the monopoly segments increase wit h increases in quality and differentiation. An increase in differentiation reduces the size of the duopoly market, while an increase in quality has an ambiguous effect on the duopoly market: for high enough equilibrium differ entiation, the size of the duopoly market decreases with an increase in qua lity. The non-cooperative FSFs pursue niche strategies, each focusing on a different related set of risks, in order to coordinate the contents of thei r reports to achieve the equilibrium degree of product differentiation. Rec ent years have seen a worldwide wave of financial-firm mergers and acquisit ions. This paper's model suggests that in equilibrium FSFs differentiate th eir products and develop profitable niches; in principle, however, sufficie ntly strong economics of scope could lead to a small number of FSFs with li ttle differentiation that dominate all financial services markets. (C) 2001 Elsevier Science B.V. All rights reserved.