Investing in Emerging Vertically Differentiated Products The Case of Voluntary GM-free Labeling 25 th June 2016, Thomas Venus

Labeling overview  In EU: Mandatory GM label  In 1998: Small UK retail chain „bans“ GM food  Until 2000: Major European retail chains follow  Not for animal products  Some European countries: Voluntary GM-free label

Stylized model: set-up  Two firms; both initially produce GM  Firm’s capacities:  Demand functions are downward sloping  Government introduces GM-free labeling standard  Quality choices: ● N … GM-free (or non-GM) quality ● G.. GM quality  Firms with capacity constraints: price setters

Initial situation: No GM-free label Duopoly GM market with capacity constraint GM demand curve

Crop farmer Livestock producer Dairy company/ Retailer

Small firm: GM-free Large firm: GM Large firm: GM-free Small firm: GM

Objective Under what conditions does large firm invests first? Under what conditions does small firm invests first? Model Two firms - Different size - Capacity constraint - Produce GM - Government introduces GM-free label - Firms can invest - Initially, GM-free profits too low - Over time, GM- free profits increase - Potential for positive profits.  Combination of entry and exit models.

Result  Results of theoretical model  Results of numerical simulation …degree of product differentiation …similarity of firm sizes CaseOutcome IBoth firms: FMAPreemption IIFirst firm: FMA; Second firm: SMAFMA-firm invests first IIIBoth firms: SMAWar of attrition FMA…First-mover advantage SMA…Second-mover advantage

Model – per-unit profits  Example: Firm 1 produces N & firm 2 produces G  Assumption: GM-free profit initially negative  BUT: Over time, N demand and hence profits increase & G prices remain constant

Increasing GM-free profits

Leader and follower value and time

If >, then FMA If >, then SMA (Note: zero interest rate, zero investment expenditure)

Case I: If both firms have FMA: -> Firm with lower preemption time leads.

Case II.2: If firm 2 has FMA and firm 1 has SMA, then firm 2 invests first.

If >, then FMA If >, then SMA

Case II.1: If firm 1 has FMA and firm 2 has SMA, firm 1 invests first.

11 Who leads, if both firms have a second-mover advantage?

Backward induction

Case III: If both firms have SMA, the firm with lower follower time invests first.

Derived demand function for vertically differentiated products  Monopoly prices  Duopoly prices …Stringency of labeling standard Forth-to-last slide

Baseline values for simulation Third-to-last slide

Simulation results Second-to-last slide 5% 2% 48% 20% 1% 24%

Conclusion  Investment in labeling requires to combine entry and exit models  GM-averse consumers gain from GM-free labeling  GM accepting consumers lose from GM-free labeling  Effect stronger if large firm invests first  Particular conditions must be considered Last slide

Questions?