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Discrete choice models of demand have typically been estimated assuming that prices are exogenous. Since unobservable (to the researcher) product attributes, such as coupon availability, may impact consumer utility as well as price setting by firms, we treat prices as endogenous. Specifically, prices are assumed to be the equilibrium outcomes of Nash competition among manufacturers and retailers. To empirically validate the assumptions, we estimate logit demand systems jointly with equilibrium pricing equations for two product categories using retail scanner data and cost data on factor prices. In each category, we find statistical evidence of price endogeneity. We also find that the estimates of the price response parameter and the brand-specific constants are generally biased downward when the endogeneity of prices is ignored. Our framework provides explicit estimates of the value created by a brand, i.e., the difference between consumers' willingness to pay for a brand and its cost of production. We develop theoretical propositions about the relationship between value creation and competitive advantage for logit demand systems and use our empirical results to illustrate how firms use alternative value creation strategies to accomplish competitive advantage. (Demand Estimation; Logit; Endogeneity; Competitive Strategy)
1. Introduction
The logit model of consumer choice has now become a standard tool for estimating the impact of marketing mix variables, such as price and sales promotions, on consumer brand choice. In marketing, the model has been extensively applied to optical scanning data collected from panels of households and to market share data (Guadagni and Little 1983, Cooper and Nakanishi 1988). The popularity of the model can be attributed to its ease of application and good predictive performance.
Researchers who estimate the logit model typically focus on consumer responses to firms' pricing and promotional decisions. In such work, prices and promotional activities are assumed to be exogenously determined. However, this assumption may not be justified in many cases. Product attributes, such as coupon availability and product image, impact consumer utility and thus affect brand choices. These variables may not be observed by the researcher, but they may influence price setting by firms. For example, empirical evidence on coupon availability suggests a positive correlation between coupon availability and retail prices, both cross-sectionally and intertemporally (Vilcassim and Wittink 1987, Levedahl 1986). Similarly, national advertising...