Abstract: A well-known principle in economics is that firms differentiate their product offerings in order to relax competition. However, in this paper we show that information frictions can invalidate this principle. We build a duopolistic competition model of second-degree price discrimination with information frictions in which (i) an equilibrium always exists with overlapping product qualities, whereas (ii) an equilibrium with non-overlapping product qualities exists only if information frictions and the costs of providing high quality are sufficiently small. As a consequence, reasons other than an attempt to soften competition should explain why firms in some cases carry non-overlapping product lines.
Keywords: product strategy, pricing strategy, second-degree price discrimination, search, vertical differentiation, retail competition.