Selection of Product Line Qualities and Prices to Signal Competitive Advantage

We investigate a firm's choice of prices and qualities of a product line to signal competitive advantage to potential entrants and to discourage entry. The market consists of customer segments with different valuations for product quality. We demonstrate that a higher quality and a higher price of each product in the line convey the firm's advantage to potential competition and prevents entry. We discuss implications for optimal product line selection when customers ‘self-select’ a product from the line. When product quality change is costly, the superior incumbent continues to select a higher quality and price for each product in the line to credibly substantiate its competitive advantage, though the distortions necessary from the optimal values are lower than before. After informative signalling and deterring entry, the firm retains the higher quality product line.