Strategic pricing and advertising in the presence of a counterfeiter

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Commercial piracy and counterfeiting are widespread phenomena in different businesses, ranging from software and video games to luxury fashion products. The International Chamber of Commerce estimates that $650 billion in counterfeit goods were sold in 2008 and that the cost of lost tax revenues due to counterfeit goods was $125 billion in developed countries alone.

Starting from the point of view that piracy cannot be deterred, due to, e.g., the absence of a concrete action by strong institutions, we model the problem as a dynamic game involving a legal producer and a pirate. To allow for the fact that pirate's entry onto the market occurs with a given delay after the launch of the product by the firm, our game involves two subperiods, namely, before and after entry. Each player controls his own retail price and advertising budget. We characterize the equilibrium pricing and advertising strategies of the two players, and assess the impact of the pirate's entry date on these strategies. Further, by contrasting the results of the scenarios with and without counterfeiting, we determine the conditions under which the presence of the illegal producer is beneficial to consumers and (even) to the legal firm.

, 24 pages

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