International Journal of Research in Marketing 34 (2017) 734–745

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IJRM
International Journal of Research in Marketing
journal homepage: www.elsevier.com/locate/ijresmar

Full Length Article

Corporate social responsibility and product quality:

Complements or substitutes?夽
Sumitro Banerjee a, * , Luc Wathieu b
a
Grenoble Ecole de Management, 12, rue Pierre Sémard, Grenoble, 38003 Cedex 01, France
b
Georgetown University, McDonough School of Business, Rafik B. Hariri Building, 37th and O Streets NW, Washington DC 20057, United States

A R T I C L E I N F O A B S T R A C T

Article history: We examine how corporate social responsibility (CSR) interacts with firm strategy, particu-
First received on April 29, 2016 and was larly product quality and price. In monopoly markets where consumers are willing to pay a
under review for 6 months premium for CSR and firms choose CSR optimally, we find that CSR is a substitute for prod-
Available online 8 July 2017 uct quality (i.e., lower quality firms invest more in CSR) under common market conditions
such as when there is a sizable segment of consumers who value product quality higher than
Guest Senior Editor: Roni Shachar
other consumers. We show that this relationship between CSR and product quality further
extends to competitive markets. Specifically, in a duopoly where the quality differentiation
Keywords: is sufficiently large, the high quality product is offered with a lower level of CSR than the
Social responsibility low quality product. Consistent with the theory, we report preliminary empirical evidence
Product quality
that suggests high end brands are significantly less likely than mainstream brands to acquire
Pricing
a strong CSR reputation. Overall, our research shows that the optimal commitment to CSR
may vary depending on other elements of firm strategy such as pricing and product qual-
ity as well as market characteristics such as market composition, competition and product
differentiation.
© 2017 Elsevier B.V. All rights reserved.

1. Introduction

Corporate social responsibility (CSR) has become a significant element of firm performance and expenditure over the past
decade or so (The Economist, 2008a). A review of the literature by Kitzmueller and Shimshack (2012) suggests that CSR lends
firms the ability, for example, to attract capital from socially responsible investors as well as labor and sales from socially
conscious and conscientious segments of the population. Accordingly, CSR has been portrayed as a self-sustaining and profit-
driven form of “enlightened self-interest” (The Economist, 2008b).
Increasingly, consumers are paying attention to socially responsible and sustainable practices of companies whose products
and services they buy (Holstein, 2008). For example, a Harris Interactive survey found that 82% of American adults claim to
be well informed about companies and brands with a strong track record for sustainability.1 Today’s consumers want to “feel
good” about the products they buy and the companies they buy them from (Thompson, 2017). In particular, consumers who

夽 The authors thank Paul Heidues, Axel Stock, and the participants of the Berlin Behavioral Economics Workshop and a research seminar at HEC for helpful
comments. They also acknowledge the Curtius Foundation (S 083/10015/2009) for financial support.
* Corresponding author.
E-mail addresses: sumitro.banerjee@grenoble-em.com (S. Banerjee), lw324@georgetown.edu (L. Wathieu).
1
Source: http://business.time.com/2012/06/15/want-more-customers-become-a-green-company/. Retrieved: 22 September 2016.

http://dx.doi.org/10.1016/j.ijresmar.2017.06.006
0167-8116/© 2017 Elsevier B.V. All rights reserved.
 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745 735

buy products sold by firms having a good reputation for CSR experience a “warm glow” effect from contributing to the social
benefit arising from CSR (Andreoni, 1989; Kitzmueller & Shimshack, 2012). CSR, therefore, may have a direct impact on sales.
According to a survey, about 81% of Americans may consider switching to a socially responsible brand (Cone Cause Evolution
Survey, 2010). Consequently, firms may invest in CSR as a means to increase consumer motivation to buy their products. In this
paper, we analyze firm decision to invest in CSR that has an impact on consumer demand for its products and consequently
profits which justifies the investment.
Importantly, in most markets, the effect of CSR on consumer demand is only secondary, i.e., the warm glow effect experienced
by consumers provides only an incremental boost to consumer utility which is driven primarily by the product benefits and
price (e.g., Kitzmueller & Shimshack, 2012 , p.73–74). Our analysis of optimal investment in CSR relies on this fundamental
observation to examine how the level of CSR interacts with the primary positioning of firms in terms of product quality and
price. In particular, we address the question whether firms selling high- or low-quality products should generally invest more
in CSR. In other words, are CSR and product quality complements or substitutes as elements of firm strategy?
Intuitively, the warm glow effect arising from CSR is likely to enhance products with an extra layer of symbolic or high-level
benefits, which is likely to appeal more to consumers at the high end of the market. At the same time, since products of higher
quality also appeal more to the high end of the market, firms that offer high quality products are therefore likely to also choose
a higher level of CSR implying CSR is a complement of product quality (e.g., Servaes & Tamayo, 2013). However, equally intuitive
arguments could also be made to the contrary. For example, CSR investment might be perceived as a digression for firms having
a strong strategic focus on high quality typically demanded by high-end markets that lends to their offers being perceived as
‘exclusive’ (e.g., Torelli, Basu Monga, & Kaikati, 2012). The objective of this paper is to resolve this conundrum by analyzing a
market equilibrium in which firms selling products in a heterogeneous market decide the optimal level of investment in CSR
and consumers decide to buy a product depending on price, quality, and CSR.
In our analysis of a monopoly, even though consumers at the high end of the market have a higher preference for CSR, we
find that a firm selling a product of lower quality to a broader market may have greater incentives to invest in CSR. Even in a
competitive market, we find that such incentives for the firm selling a low quality product, although lower than in monopoly,
may exceed that of the firm selling a high quality product when the degree of differentiation is sufficiently large and the size of
the high end of the market is relatively small. In sum, the paper highlights that in markets where the cost of CSR is ultimately
borne by consumers who buy products offered by a firm, the optimal spending on CSR depends on the market structure and
intensity of competition.
Our model examines a market consisting of consumers with heterogeneous preferences for both product quality and CSR in
a monopoly and a competitive market where consumers account for CSR while making their purchase decision.2 All along, we
assume that only those who buy a firm’s product experience a “warm glow” from the CSR created by the firm and pay for it.
Others who do not buy the product only receive the social benefit delivered by CSR. Our main finding is that CSR is a substitute
and not a complement of product quality under common market conditions such as when there is a sizable segment of high-
end consumers. In a monopoly, the intuition is that when the product quality is higher than a threshold, the firm earns more
by charging a higher price and targeting only the high end of the market. As a result, only a fraction of consumers present in
the market experience the warm glow effect from CSR which restricts the firm’s return on CSR investments. A firm selling a
product of lower quality, in contrast, has incentives to increase the sales volume, i.e., sell more broadly to a larger number of
consumers, since it can charge only a lower price due to the lower quality of its product. Accordingly, a larger consumer base
that buys a product of lower quality, also experiences the warm glow effect of CSR which allows such a monopolist to increase
the price and profits by investing more in CSR. This result, despite being weaker under competition, i.e., a firm selling a lower
quality product is pressured by a competitor selling a higher quality product to reduce investment in CSR, still persists when the
competing firms are sufficiently differentiated. In other words, in a sufficiently differentiated duopoly, the firm selling a lower
quality product may still invest more in CSR than its competitor implying CSR may be a substitute of product quality even in
competitive markets.
The rest of the paper is organized as follows. Section 2 provides a literature review. Section 3 provides a model and analysis
of a monopolist selling a product in a segmented market and choosing the amount to spend on CSR. Section 4 extends the model
to a duopoly market. Section 5 examines the robustness of our results to market conditions where consumer taste for quality is
continuously distributed, firms decisions include product quality, and governments provide subsidies to CSR. Section 6 provides
some supportive evidence and Section 7 concludes.

2. Related literature

Despite early skepticism towards CSR (Friedman, 1970), there is an emerging consensus that firms actually may have market
incentives to invest in CSR (Baron, 2001; Kitzmueller & Shimshack, 2012). As the cost of CSR is ultimately borne by consumers,
understanding consumer preference for CSR has been a topic of growing research interest (e.g., Krishna & Rajan, 2009).

2
This analysis can also be extended to a market situation under asymmetric information where consumers cannot observe CSR. We leave this for future
research.
736 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745

One reason firms engage in CSR activities is that consumers experience a “warm glow” from “doing good” (e.g., Andreoni,
1989) by purchasing a product from a socially responsible firm which translates to a higher willingness to pay for the primary
products sold by the firm (e.g. Cone Cause Evolution Survey, 2010). For example, the rental rates and sales prices of green rated
buildings in the US were significantly higher than that of unrated buildings, matched on attributes such as quality and location
(Eichholtz, Kok, & Quigley, 2010). We consider the warm glow effect as an important factor that determines the level of CSR
chosen by firms.
Research has also found that consumer evaluation of CSR interacts with other relevant attributes of the firm’s offer. For
example, consumers seem to value CSR more when the product quality is high (Servaes & Tamayo, 2013). In contrast, experiments
have shown that consumers value high quality or luxury brands less when they are aware of CSR (e.g., Torelli et al., 2012)
because it may reduce their perceptions of exclusivity associated with the brand. Similarly, consumer focus on certain types
of brand attributes (such as strength or product effectiveness) may have a negative impact on consumer preference for CSR or
sustainability-related attributes (Luchs, Naylor, Irwin, & Raghunathan, 2010). Iyer and Soberman (2016) have analyzed social
comparison of CSR-related purchases to suggest that in equilibrium, CSR can affect firm incentives to innovate. However, whether
a firm selling a high- or a low-quality product should choose a higher or lower level of CSR investment remains to be ascertained.
The role of competition as a determinant of CSR has also not been conclusively established in the literature. On the one hand,
CSR helps firms to gain competitive advantage over firms that do not commit to CSR (Bagnoli & Watts, 2003). On the other hand,
though, intense competition may erode levels of CSR (Bagnoli & Watts, 2003; Bennett, Pierce, Snyder, & Toffel, 2013; Branco &
Villas-Boas, 2015) . None of these studies, however, explicitly consider consumer and firm trade-offs between product quality
and CSR while taking market competition into account. We examine the effect of competition on CSR in a market with two
vertically differentiated firms to show that effect of competition on CSR may be contingent on product quality.
In the following section, we develop and analyze a monopoly model of a socially responsible firm.

3. Monopoly market

Consider a monopolist selling a product of quality v ≥ 0 at price p in a market consisting of a unit mass of potential
consumers who are heterogeneous in taste for product quality. Quality is a “vertical” dimension of product performance,
i.e., if products were free, all consumers would choose a product of the highest available quality. But owing to variation in
underlying characteristics such as income or education, consumers are heterogeneous in their willingness to pay for quality.
This set-up creates an opportunity for vertical differentiation between products of high and low quality (Tirole, 1988). More
specifically, we assume that consumers are of two types i ∈ {L, H} with a taste for product quality hi ∈ [0, 1] and hH > hL . Each
segment is of size ki which we simplify by denoting kL = k (e.g., Banerjee & Soberman, 2013). Hereafter, consumers of type
i = L are referred simply as “lows”, and i = H as “highs”.
The firm has an opportunity to invest in CSR to generate a social good of value r hereafter referred simply as “CSR”. The
necessary investment is C(r) which is convex such that C (r) ≥ 0 and C (r) > 0. In particular, we assume C(r) = r2 /(2m) where
m > 0 is the efficiency of producing CSR through social activities or investment.3
Consumers who buy the firm’s product experience a consumption utility ubi = hi v + bi r − p (similar to Krishna & Rajan,
2009) when ubi ≥ 0. Due to the nature of CSR, we also assume a “social utility” experienced by consumers who do not buy the
firm’s product is given by usi = abi r where a ∈ [0, 1). This is the direct benefit of CSR derived by the general public.
We impose, in addition, some parametric restrictions to capture the common sense characteristics of CSR. First, CSR is only a
secondary factor affecting consumer utility: it is not the primary driver of purchasing behavior. That is, consumers rely more on
product quality than CSR when they decide to buy a product. Accordingly, all consumers have a greater taste for product quality
than for CSR (hi > bi ) and we assume m ≤ v to ensure that any consumer i derives higher utility from product quality (hi v)
than from CSR (bi r). Second, consistent with the notion that CSR is a secondary factor affecting consumer utility, we also assume
a lower variation in consumer valuation of CSR compared with product quality. In other words, we assume that consumer
heterogeneity is greater in terms of taste for quality than for CSR, i.e., hH /hL > bH /bL . Third, we assume bL ≤ bH consistent
with the empirical findings of the literature (Kitzmueller & Shimshack, 2012, p. 61–62).4 Summarizing, parameters hi , bi and
ki represent three different forms of heterogeneity in the market, and our goal is to precisely analyze how the parameters hi
and ki (which determine the market demand for a given product quality) interact with the parameter bi (which represents the
sensitivity to CSR) to impact the CSR decision in relation to product quality.
Given the above conditions, the incremental consumer utility from buying the product offered by the firm over not buying is
the difference

Dui = ubi − usi = hi v + (1 − a ) bi r − p. (1)

3
In many markets, governments may provide incentives or subsidies to firms for CSR which may be incorporated into our model by modifying the cost of
CSR as C(r) = r2 /(2m) − sr where s ≥ 0. Implications of such subsidies are discussed in Section 5 with details in Appendix A.3.
4
All the results and insights of this paper hold even if we substitute bL = bH (same as Krishna & Rajan, 2009). Nevertheless, for generality, we retain both bL
and bH .
 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745 737

A consumer i therefore chooses to buy the firm’s product only if Dui ≥ 0, i.e., hi v + (1 − a)bi r ≥ p. Here, the component (1 − a)bi r
of Dui captures the “warm glow” effect experienced by those consumers who buy the product and thereby “finance” the CSR
investment of the firm. In other words, 1 − a is the fraction of the utility of CSR that leads to warm glow of the that comes from
contributing to CSR level r. In contrast, those consumers who do not buy the firm’s product ‘free ride’ on the warm glow of the
buyers to derive the direct social benefit (usi ) from CSR. Since DuH > DuL , the unitary aggregate market demand where each
consumer buys at most one unit of the product is given by
⎧
⎪
⎪
⎨0 if DuH < 0,
D = 1 − k if DuL < 0 ≤ DuH , (2)
⎪
⎪
⎩1 if Du ≥ 0.
L

Assuming a constant marginal cost of production c ∈ [0, hL v), the firm’s profit is given by

p = (p − c ) D − C (r ) . (3)

The timing of the game is as follows. The firm maximizes profit by simultaneously choosing the price p and CSR r, all other
parameters being common knowledge. Consumers then decide whether or not to purchase at most one unit of the firm’s
product. This leads us to the following result.

1−k h 1−k b
Proposition 1. a) When ( h ) H > ( b ) H ≥ 1, the monopolist serves only the highs by choosing a price p∗ = hH v +
L L
m(1 − a )2 (1 − k ) b H
2
and CSR r∗ = m(1 − a)(1 − k)bH . The lows, who are not served, obtain a positive surplus due to the
social utility abr∗ of the CSR. b) When ( h ) H > 1 > ( b ) H , there exists a threshold v̂ of product quality such that when
1−k h 1−k b
L L  
v > v̂, the monopolist serves only the highs by choosing a higher price pH = hH v + m(1 − a )2 (1 − k) bH
2
but a lower level of CSR
(rH = m(1 − a)(1 − k)bH ). Here,


m(1 − a )2 bL2 − (1 − k)2 bH
2
/2 − kc
v̂ = . (4)
(1 − k) hH − hL
 
In contrast, when v ≤ v̂ , the monopolist serves all consumers in the market by choosing a lower price pM = hL v + m(1 − a )2 bL2
1−k h 1−k b
but a higher level of CSR (rM = m(1 − a)bL ). c) When 1 ≥ ( h ) H > ( b ) H , the monopolist serves the entire market by choosing a
L L
lower price (pM ) but a higher level of CSR (rM ) when v > v̂ . In contrast, when v ≤ v̂, the monopolist serves only the highs at a higher
H H
price (p ) and a lower level of CSR (r ).

In a monopoly, CSR and price depend on product quality and consumer heterogeneity. Proposition 1 highlights two possible
scenarios, one suggesting that CSR is a substitute for product quality (higher quality leads to a lower investment in CSR), the
other suggesting that CSR is a complement of product quality (higher quality leads to a larger investment in CSR).
First we consider the scenario where CSR is a substitute for product quality as stated in part b) of the proposition. When the
market consists of a higher proportion of quality sensitive consumers (the highs), the firm selling a product of quality above
a threshold (v > v̂) targets only the highs. Targeting only the highs, on the one hand, allows the firm to charge a higher price
which increases its margin. On the other hand, by not serving the remainder of the market, the firm loses sales to the lows
thereby reducing its consumer base. The lows, who are not served and consequently do not contribute to CSR, nevertheless “free
ride” on the social benefits of CSR. Since only the highs experience warm glow and therefore contribute to CSR, the firm earns a
lower return on its investment in CSR than when it covers the entire market. As a result, such a firm commits lower resources
to CSR than it would have if it sold its product to the entire market in which case both the highs and lows would experience
warm glow and therefore contribute to CSR. Notice that under this scenario, v̂ increases as the fraction of social utility (1 − a)
comprising warm glow, or the firm efficiency (m) of producing CSR increases, making it more likely for the entire market to be
served by the monopolist.5
A firm selling a product of quality lower than the threshold (v ≤ v̂), in contrast, earns a higher profit by selling the product
broadly across the entire market which results in a warm glow experience for all consumers present in the market. Since the
entire market contributes to CSR, such a firm earns higher returns on its investment in CSR and hence commits to a higher level
of CSR than a firm that selectively targets only the highs. Under this scenario, therefore, CSR is a substitute for product quality:
a firm selling a higher quality product spends less on CSR than one selling a product of lower quality.
CSR is a complement of product quality in the second scenario described in part c) of the proposition. In a market consisting
of a lower proportion of highs whose taste for product quality is not considerably higher than the lows, the firm earns higher

dv̂ dv̂
5
Under scenario b), d(1−a)
≥ 0 and dm
≥ 0 since (1 − k)hH > hL .
738 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745

profits by serving the lows. Since the highs have a higher willingness to pay for the same product quality, at any price at which
the lows are willing to buy the firm’s product, the highs too are willing to do the same. Consequently, a firm that targets the lows
in the market also sells its product to the highs thereby covering the whole market.6 Since complete market coverage leads to all
consumers experiencing warm glow from contributing to CSR, the firm earns high returns on investment in CSR and therefore
commits to a high level of CSR. Under this scenario, a firm selling a product of quality v > v̂ serves the entire market to serve the
attractive segment which consists of the lows. The quality threshold v̂, contrary to scenario b), decreases as the fraction of social
utility (1 − a) comprising warm glow, or the firm efficiency (m) of producing CSR increases, but again making it more likely for
the entire market to be served by the monopolist.7
However, if product quality is below a threshold given the marginal cost remaining the same, a squeeze on the margin may
force such a low quality firm to paradoxically seek a higher margin by selectively targeting the highs. In that case, the firm earns
a higher profit by charging a higher price which only the highs are willing to pay, despite the drop in revenues due to lower
sales than when it covers the market. Thus, a firm offering a low quality product charges a higher price and commits to a lower
level of CSR than a high quality firm which covers the market. Typical examples of such strategies and market situations are
new markets where firms sell initial products that are not of very high quality at a high price to a small fraction of interested
consumers. The model predicts that such firms selling such low quality products to a small fraction of the market will commit
to a lower level of CSR than firms which sell higher quality products broadly across the entire market. Hence, in markets where
the lows comprise a large majority, CSR is a complement of product quality as an element of firm strategy: the level of CSR is
higher only when the product quality is above a threshold.
On the contrary, when the fraction or the relative taste for quality of the highs in the market is considerably large as under
the remaining scenario mentioned in part a) of the proposition, the optimal choice of CSR is independent of product quality. The
highs, in that case, are clearly more attractive to serve than the lows because the firm can charge them a higher price for any
given product quality and also choose a level of CSR commensurate with their warm glow experience. This strategy, although
effectively the same as the optimal strategy of a firm selling a product of quality higher than a threshold (v > v̂) (ref. part b of
the proposition), is optimal independent of the quality of the product offered by the firm.
Only under the intermediate conditions where (1−k)h hL
H
> 1 > (1−k)b
bL
H
as mentioned in part b) of the proposition, the firm
must decide between serving only the highs which restricts its commitment to CSR, and selling broadly to the entire market
which results in a market wide experience of the warm glow effect that induces a greater commitment to CSR. We have shown
that under such conditions, CSR is a substitute for product quality: a firm selling a product of high quality serves only the highs
and chooses lower level of CSR than one selling a product of low quality which serves the entire market. Next, we extend this
analysis to a competitive market in order to understand how competition impacts the relationship between product quality and
CSR.

4. Duopoly

As in the case of a monopoly, in a duopoly the “consumption” utility of consumers buying firm j s product is ubij = hi vj +bi rj −
pj and the “social” utility of CSR obtained by consumers who choose not to buy the firm j s product (i.e., ubij < 0) is usij = abi rj .
Denoting Duij = ubij − usij , consumer i decides to buy the product offered by the firm j if Duij ≥ max{Dui,−j , 0} where Dui,−j is her
net utility of buying the product offered by the other firm. As stated earlier, since CSR is a public good, a consumer i who buys
from firm j also receives ‘free riding’ utility abi r −j from the CSR of the competing firm −j.
In a duopoly, firms offering the same product quality, having the same marginal costs (cj = c) and the same efficiency of CSR,
would compete away their profits in an ensuing Bertrand equilibrium where prices of both firms collapse to the marginal cost
(e.g., Tirole, 1988). Alternatively, if one of the firms (hereafter, “the high quality firm”) offers a product of higher quality but is
identical in all other attributes to the second (hereafter, “low quality”) firm, the high quality firm has the option to either cover
the entire market by charging a price such that DuiH ≥ DuiL for all consumers, i.e., pH ≤ hL (vH − vL ) + (1-a)bL (rH − rL ) − pL where
pL will eventually drop to the level of c and lead to rL = 0, or serve only the highs allowing the low quality firm to serve only the
lows as explained below.
If the high quality firm serves only the highs (i = H), it charges a price at which DuHH − DuHL ≥ 0 and DuLH − DuLL < 0.
Denoting Dv = vH − vL and Dr = rH − rL , this implies hL Dv + (1 − a)bL Dr < pH − pL ≤ hH Dv + (1 − a)bH Dr. The low quality
firm, in that case, serves only the lows (i = L) by charging a price arbitrarily lower than a price at which DuLL ≥ 0, i.e., pL ≤
hL vL + (1 − a)bL rL .8 Alternatively, if the high quality firm covers the entire market, it charges a price at which DuLH − DuLL ≥ 0,
i.e., pH − pL ≤ hL Dv + (1 − a)bL Dr.

below which the high
Proposition 2. In a vertically differentiated duopoly, there exists a threshold level of differentiation Dv ≤ Dv
quality firm covers the entire market and chooses a higher level of CSR but a lower price than a high quality monopolist. In contrast,
when the level of differentiation is above the threshold, the high quality firm serves the highs and the low quality firm serves the lows.

6
As a result, the high derive a higher surplus than the lows under such conditions.
dv̂ dv̂
7
Here d(1−a) < 0 and dm < 0 since (1 − k)hH < hL .
8
These strategies are the same even when firms have different marginal costs: cH > cL . We consider the simplest case where cH = c = cL .
 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745 739

The high quality firm chooses the same level of CSR but a lower price than a high quality monopolist. The low quality firm chooses
a lower price and CSR than a low quality monopolist. Further, the level of CSR of the low quality firm is higher than that of the high
quality firm if

k bH
≥ . (5)
1−k bL

Firms that are vertically differentiated on product quality choose different prices and levels of CSR in a duopoly compared
to monopolists. When the differentiation between the competing firms is below a threshold, the high quality firm chooses
a lower price but a higher level of CSR in a duopoly than a high quality monopolist, but covers the entire market. On the
one hand, covering the market allows the high quality firm to benefit from a large base of consumers who pay for CSR by
purchasing its product, which is the reason why it chooses a higher level of CSR than a monopolist which serves only the highs.
On the other hand, the price has to be significantly lower to not only attract the lows, but also deter them from buying the
low quality firm’s product. In effect, this strategy of the high quality firm leads to decisions and a market position similar to
a low quality monopolist (Proposition 1) except for the price. As a result, CSR is a complement of product quality in a duopoly
when the differentiation between the firms is lower than a threshold Dv
(see Eq. (22) in Appendix). In other words, the lower the
differentiation between firms, the more likely the high quality firm will cover the market and choose a higher level of CSR.
In contrast, when the level of differentiation between the competing firms is above the threshold, CSR may be a complement
or substitute of product quality depending on the relative sizes of the market segments. The high quality firm continues to serve
only the highs in a competitive market like a high quality monopolist, and the low quality firm serves only the lows unlike a
low quality monopolist which serves the entire market. Since the level of differentiation between the firms is high, the intensity
of competition is lower which allows both firms to earn a profit. The high quality firm chooses the same level of CSR as a high
quality monopolist but a lower price to prevent the highs from buying the low quality firm’s product.
Because the competing low quality firm serves only the lows unlike a low quality monopolist which serves the entire market,
it earns lower return on investment in CSR. Therefore, the low quality firm chooses a lower level of CSR and a lower price owing
to a lower taste for quality of its consumers in this market. The CSR of the low quality firm, nonetheless, may still be higher
than that of the competing high quality firm if the market size of the lows, or the ratio of the taste for CSR of lows to highs is
sufficiently large. As a result, under such conditions CSR is a substitute for product quality even in a duopoly.
Although the literature suggests that competition generally has an adverse effect on CSR (Branco & Villas-Boas, 2015; Bennett
et al., 2013), Proposition 2 shows that CSR of firms differing on product quality is affected differently by market competition. In
a vertically differentiated market, a competing high quality firm chooses a higher level of CSR than a high quality monopolist if
the level of differentiation is low. When the level of differentiation is high, in contrast, the competing high quality firm chooses
the same level of CSR as a high quality monopolist.
Moreover, in a duopoly both types of consumers derive the total social utility from CSR of both firms. Although CSR of the
low quality firm is lower under duopoly, leading to lower social utility, it is more than compensated by the social utility from
the CSR of the high quality firm.9 The highs derive additional surplus due to a lower price as well as a higher CSR when the high
quality firm covers the market (Dv ≤ Dv).
When the high quality firm serves only the highs, their surplus is the same as under a
high quality monopolist with an additional social surplus from the CSR of the low quality firm which serves the lows.

5. Robustness

So far we have considered a binary market consisting of only two types of consumers. In a market with a continuous and
uniform distribution of consumers’ taste for quality but a fixed taste for CSR, however, we replicate our finding that CSR is a
substitute for product quality, provided the production of CSR is sufficiently efficient (see Appendix A.1).
Further, CSR is only one of the many decision variables available to firms, allocating resources to which may improve their
market performance. Firms also have opportunities to improve product quality through R&D, or change product perception
through communications to increase profits. Considering a firm with a base quality v as before and allowing the firm to improve
its quality or its perception to v + w by incurring a convex cost of development R(w) = w2 /(2k) where k > 0 is the prod-
uct development capability of the firm, we find (see Appendix A.2) that a firm having a product of higher base quality v also
chooses higher w but lower CSR to serve only the highs. The qualitative results remain the same (Propositions 1 to 2) but the
quality threshold is v̂ −k[(1 − k)hH − hL ] instead of v̂ in a monopoly and the threshold level of differentiation in a duopoly is
2 2 2

−k (1−k) hH −(1−k)k(hH −hL )hL −k hL instead of Dv.

Dv
When firms can invest in improvement of product quality, our main result is
2
reinforced as firms selling a high quality product tend to favor further quality improvements over CSR.
Finally, in some markets, governments may provide incentives or subsidies to firms for CSR (e.g., Arya & Mittendorf, 2015).
Our model can be extended to account for this effect (denoted by s) in the cost of CSR as C(r) = r2 /(2m) − sr where s ≥ 0. Such

9
Refer to proofs of Propositions 1 and 2 in Appendix: rHC + rLC ≥ rL when bH ≥ bL consistent with empirical findings (Kitzmueller & Shimshack, 2012,
p. 61–62).
740 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745

a subsidy increases the level of CSR by an increment ms which in turn also increases the price by an increment ms(1 − a)bi
because CSR is also a weighted component of price. Consequently, the profit also increases due to the increase in price as the
demands remain unchanged. The qualitative insights from the model, as shown in Appendix A.3, remain the same as long as the
subsidy is within reasonable limits, i.e., s < s̄. In contrast, a higher subsidy (s ≥ s̄) overrides all other strategic considerations
driving CSR in our model.

6. Supportive evidence

Our analysis opens up several new possibilities of empirical research, particularly on the relationship between perceived
product quality and CSR performance of firms. The key to a thorough empirical examination of the relationship predicted by
our model is to develop a measure of the quality of products sold by companies listed in data sets such as KLD STATS, consisting
of CSR performance ratings (Servaes & Tamayo, 2013).10 In addition, industry-specific consumer ratings of CSR might capture
consumer taste for CSR, a key ingredient of our model. Our model predicts that consumer ratings of product quality will have a
negative impact on CSR performance particularly in concentrated markets, when consumers are sufficiently heterogeneous (as
captured, e.g., by variance in quality ratings or consumer characteristics). In the most commonly encountered market structure
which includes a relatively broad low-end segment and a narrow high-end segment, our results suggest that CSR is a substitute
for product quality. In competitive markets too, where firms are vertically differentiated on product quality and the variance in
quality ratings of firms is sufficiently high reflecting sufficient degree of differentiation, product quality ratings will also have a
negative impact on CSR ratings in the presence of a larger proportion of consumers with lower preference for product quality.
Such a full-fledged empirical validation of our results is beyond the scope of this paper and therefore left for future research.
Nonetheless, we provide some supportive evidence to illustrate our basic results.
We asked a sample of 255 M-Turk participants each to rate 30 brands randomly drawn from the 148 brands across those
appearing in the RepTrak®100 for the year 2017 and Interbrand’s 100 Best Global Brands of 2016, which generated an average of
51.6 responses for each brand. For the purpose of this illustrative study, we interpret a company being listed in the widely known
RepTrak®100 of the Reputation Institute, as an indicator of “a strong CSR” reputation which we use as a dependent variable in
our study.11 Similarly, we consider all brands listed in Interbrand’s 100 Best Global Brands as a benchmark for comparison.12
To validate our results across high and low quality products, we operationalized high quality products as brands that are sold
exclusively to the high end segments in the market and therefore perceived as “exclusive” by the respondents. Similarly, we
operationalized low quality products among the brands appearing in the two lists as those which are sold more broadly across
different market segments and hence perceived as “mainstream” brands. The participants were asked to evaluate each brand
on a 5 point scale of between “definitely mainstream” and “definitely exclusive” (the midpoint being “neither mainstream nor
exclusive”). Participants were told that exclusive brands are those that are adopted by a narrow range of high end customers;
they charge a premium price; and they offer products and services that are known for their clearly superior quality. Participants
were told that the mainstream brands, in contrast, are adopted by a broad range of customers; they charge a more affordable
price; and they offer products and services that are known for their good to very good quality. We also allowed participants
an option of choosing “I don’t know”. From this data, we categorized a brand as “mainstream” if more than 50% of respondents
gave it a rating of 1 or 2 (i.e., if the majority of respondents identified the brand as mainstream), and as “exclusive” if more than
50% of respondents gave it a rating of 4 or 5.
Among the 100 brands listed by Interbrand, 66 were categorized as mainstream in our survey, and 44 (66.7%) of these
mainstream brands appeared in the RepTrak list of strong CSR brands. In contrast, 21 brands were categorized as exclusive,
and only 2 (9.5%) of these exclusive brands appeared in the RepTrak list of strong CSR brands. A highly significant Fisher’s test
(p < .0001) lends support to our theory that, in common market conditions, high quality/high price brands are less likely to
select a high CSR positioning than lower quality brands which appeal to the broader market. In other words, CSR is a substitute
for product quality.
To cross-validate this analysis, we found that among the 52 brands from the Interbrand list that could be categorized as strong
in CSR (based on them appearing among the RepTrak 100), 44 (84.6%) were mainstream, while there were only 22 mainstream
brands (45.8%) among the 48 brands on the Interbrand list that were not deemed strong in CSR (Fisher’s test p < 0.0001).
Similarly, among the 52 Interbrand brands that are strong in CSR, only 2 of them (3.8%) were categorized as exclusive, while the
proportion of exclusive brands among those not listed in RepTrak was 19/48 (39.6%) (Fisher’s test p < .0001).

7. Conclusion

This paper shows how firm decision to invest in CSR should depend on product quality when consumers experience a warm
glow effect. While CSR investments are typically considered and analyzed as company-level decisions (e.g., Servaes & Tamayo,
2013, and Krishna & Rajan, 2009), our results indicate the need for CSR efforts to be integrated with product policy because of

10
Website: www.kld.com.
11
Source: https://www.reputationinstitute.com/Resources/Registered/PDF-Resources/2017-Global-RepTrak-Most-Reputable-Companies-in.aspx (accessed
6 March 2017).
12
Source: http://interbrand.com/best-brands/best-global-brands/2016/ (accessed 6 March 2017).
 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745 741

their influence on consumer choices at the product-market level. Just like pricing, CSR needs to be adjusted to product charac-
teristics (e.g., quality) and market characteristics (e.g., consumer heterogeneity and willingness to pay; level of differentiation
with respect to competitors) to maximize returns.
We show that if there is a sizable segment of quality-sensitive consumers, a firm selling a high quality product should target
this segment with a higher price and a lower level of CSR, while a firm selling a lower quality product should address the broader
market with a lower price and a higher level of CSR investment. While extant research has discussed various relationships
between CSR and product quality preferences at the consumer level (e.g., Torelli et al., 2012, and Luchs et al., 2010), our analysis
examines this relationship under a market equilibrium. We find that CSR acts as a substitute for product quality as a strategic
decision of firms − even when there is a positive relationship between CSR and product quality preferences at the consumer
level.13 This is a key insight for managers as firms grapple with spending limited resources across alternative ways to enhance
their business.
A question of considerable practical and academic interest is how competition affects CSR and its relationship with product
quality. The literature suggests that intense competition may erode levels of CSR (Bagnoli & Watts, 2003; Bennett et al., 2013;
Branco & Villas-Boas, 2015). It was not clear, however, how product quality and the level of differentiation between competing
firms affects CSR. Our results show that competition between vertically differentiated firms does not change the level of CSR
selected by high quality firms as compared to their monopoly levels. However, competition does lower the CSR investment of
low quality firms as compared to their monopoly levels because they serve a smaller market under competition as compared to
monopoly and will therefore earn lower revenues to support CSR activities. And yet, CSR of a low quality firm may still exceed
its high quality competitor’s if the market size or taste for CSR of the consumers at the low end of the market is sufficiently high.
When such is the case, CSR is still a substitute for product quality even in competitive markets.
Our research also has several limitations. We have considered a static model without examining continued or long term
benefits of CSR for either firms or consumers. It is likely that CSR also changes consumer behavior over time, for example,
by increasing their willingness to repeatedly purchase a firm’s product or simply by improving their lives. Dynamic models
of changes in consumer behavior, particularly their response to CSR would offer interesting insights. Further, consumers may
also not be able to judge their true valuation of CSR which may offer firms an opportunity to implement behavior based price
discrimination strategies. Moreover, relaxing the assumption about additive separability of product quality and CSR in consumer
utility function may also offer some new insights.
CSR being a public good, non-buyers free ride on the warm glow of buyers of the firm’s product to derive a social utility
from CSR. To extend this idea also to firms that derive a warm glow benefit in addition to monetary profits, not included in this
analysis, can further increase the level of CSR as well as a positive externality on CSR by non-buyers on the level of CSR chosen
by firms.
Since CSR activities are typically communicated through public relations, whether they are successfully implemented or
meet high standards of implementation, remains questionable despite the rise of detailed reporting of CSR activities by firms
(The Economist, 2008c, 2008d; Yoon, Gürhan-Canli, & Schwarz, 2006; Heyes & Martin, 2016). Asymmetric information about
CSR between firms and consumers may be another interesting area of research. It may be interesting to examine, for example,
whether firms have incentives to exaggerate claims of CSR when consumers cannot observe the true implementation of CSR
(Lyon & Maxwell, 2011).
We have shown that CSR is a substitute of product quality as an element of firm strategy under reasonable market conditions.
As a consequence, one of the empirical predictions of the model is that consumers who correctly anticipate a firm’s trade-off
between product quality and CSR, may also exhibit relatively lower overall preferences for high quality products when they are
aware of CSR which is also consistent with the experimental results of Torelli et al. (2012).

Appendix A

A.1. Continuously distributed consumers

Consider a market where consumer taste for product quality h is continuously distributed assuming, for simplicity, a uniform
distribution h ∼ U[0, 1], and a fixed taste for CSR b. The rest of the modeling assumptions being the same as in Section 3,
consumer utilities are given by ub = hv + br − p and us = abr. The monopolist’s demand for its product is given by D = 1 − ĥ
p−(1−a )br
where ĥ solves Du = ub − us ≥ 0, i.e., ĥ = v . Solving the monopolist’s profit maximization problem to decide price and
v(v−c) m(1−a )b(v−c)
CSR, we get pM = c + M
and r = . Note that pM c requires the condition v m(1 − a)2 b2 2 which is
> > /
2v−m(1−a )2 b2 2v−m(1−a )2 b2
   
M 2v v−m(1−a )2 b2 +m(1−a )2 b2 c M m(1−a )2 b2 −2c (1−a )mb
guaranteed since m < v. Further, dpdv =  2 0 , and drdv = −
>  2 ≤ 0 if m ≥ 2c
2v−m(1−a )2 b2 2v−m(1−a )2 b2 (1−a)2 b2

13
There is some anecdotal evidence for such behavior in markets. For example, the Ethical Consumer Research Association (UK) records lower ratings for
luxury brands on sustainability and CSR. (Source: http://www.corporatecritic.org/info/about/ethicalconsumer.aspx. Last accessed on 28 March 2014.)
742 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745

M
and drdv > 0 otherwise. There is an inverse relationship between CSR and product quality when the efficiency of CSR is above a
threshold.
Similarly, in a duopoly the demand for the high quality firm is given by DH = 1−ĥH where ĥH solves the condition DuH −DuL =
Dp−(1−a )bDr
ubH − usH ≥ ubL − usL , i.e., ĥH = Dv where Dv = vH − vL , Dr = rH − vL , Dp = pH − pL , and vH /pH < vL /pL . The demand
p − 1−a br
for the low quality firm is given by DL = ĥH − ĥL where ĥL solves DuL ≥ 0, i.e., ĥL = L ( v ) L . Solving simultaneously the profit
L
maximization problem of the two firms, we get
     
vH vL (vH − vL ) (2 (vH − vL ) + 3c) − m(1 − a )2 b2 (vH − vL ) c (vH + vL ) + v2H − m(1 − a )2 b2 − 2vL vH c
pH =   ,
vL (4vH − vL ) (vH − vL ) − m(1 − a )2 b2 (2vH − vL ) (vH + vL ) − m(1 − a )2 b2 vH
 
vL (vH − vL ) (vH (vL + 2c) − vL (vL − c)) − m(1 − a )2 b2 2cv2H + v2L (vH − vL ) − m(1 − a )2 b2 vH c
L
p =   ,
vL (4vH − vL ) (vH − vL ) − m(1 − a )2 b2 (2vH − vL ) (vH + vL ) − m(1 − a )2 b2 vH
 
m (1 − a ) b vL (2vH − c) (vH − vL ) − m(1 − a )2 b2 vH (vH − c)
rH =  ,
vL (4vH − vL ) (vH − vL ) − m(1 − a )2 b2 (2vH − vL ) (vH + vL ) − m(1 − a )2 b2 vH
 
m (1 − a ) bvH (vL − 2c) (vH − vL ) − m(1 − a )2 b2 (vL − c)
rL =  .
vL (4vH − vL ) (vH − vL ) − m(1 − a )2 b2 (2vH − vL ) (vH + vL ) − m(1 − a )2 b2 vH

 
2 2  
vH −vL (2vH −vL )c+vH vL −m(1−a ) b
Here, rH /rL = 1 + vH (v −2c)(v −v )−m(1−a )2 b2 (v −c) . Therefore rH ≥ rL if m(1 − a )2 b2 ≤ (vH − vL ) 1 − c
vL −c and rH < rL
L H L L
otherwise.

A.2. Including product quality decision

Including a decision to improve product quality v by a magnitude w leads to a monopolist’s decision (similar to Proof of
Proposition 1) when DuL < 0 ≤ DuH , i.e., D = 1 − k as max p s.t. p ≤ hH (v + w) + (1 − a)bH r.14 Solving, we get wH = k(1 − k)hH ,
p,,r
rH = m(1 − a)(1 − k)bH , pH = hH [v + k (1 − k) hH ] + m (1 − k) (1 − a )2 bH
2
, and the resulting profit

pH = (1 − k) [hH (v + k (1 − k) hH ) − c] + m(1 − a )2 (1 − k)2 bH

2
/2. (6)

Note that the condition hH [v + k(1 − k)hH ] > bH rH is satisfied since hH > bH and v > m.
Similarly, when DuL ≥ 0, i.e., D = 1, the firm’s decision max p s.t. p ≤ hL (v + w) + (1 − a)bL r solves as wM = khL ,
p,,r
rM = m(1 − a)bL , and pM = hL (v + khL ) + m(1 − a )2 bL2 leading to profit

pM = hL (v + khL ) − c + m(1 − a )2 bL2 /2. (7)

The condition hL (v + khL ) > bL rM is satisfied since hL > bL and v > m. 

Comparing, we have pH ≥ pM if [(1 − k) hH − hL ] [v + k ((1 − k) hH − hL )] + kc ≥ m(1 − a )2 bL2 − (1 − k)2 bH
2
/2 which leads
to analogous results as Proposition 1 with the only change being the threshold v̂ − k ((1 − k) hH − hL ) instead of v̂.
In a duopoly, the decisions of a high quality firm which serves the entire market by preventing a low quality firm to sell
2
rH w2H
its product are given by max pH − c − 2m − 2k
subject to pH − c ≤ hL (Dv + wH ) + (1 − a)bL rH . Solving, we get wHM = khL ,
pH ,rH wH
rHM = m(1 − a) bL , and pHM = h L (Dv + khL ) + m(1 − a)2 bL2 + c leading to profit

m(1 − a )2 bL2
pHM = hL (Dv + khL ) + . (8)
2

Comparing with results under monopoly above, we have wHM = wM , rHM = rM , pHM ≤ pM (v = vH ) since c ≤ hL vL and pHM ≤
pM (v = vH ).
Similarly, the decisions of a high quality firm which serves only the highs allowing a low quality firm serving only the lows
2
rH w2H
are given by max (pH − c) (1 − k) − 2m − 2k
subject to pH − pL ≤ hH (Dv + Dw) + (1 − a)bH Dr. Simultaneously the low
pH ,rH ,wH

14
Note that w can also be interpreted as advertising or communication that increase the quality perception among consumers.
 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745 743

rL2 w2L
quality firm solves max (pL − c) k − 2m −subject to pL ≤ hL (vL + wL ) + (1 − a)bL rL . Solving, we get wHC = k(1 − k)hH ,
2k
pL ,rL ,wL
 
rHC = m(1 − a)(1 − k)bH , and pHC = hH vH − (hH − hL ) vL + k[(1 − k) h2H − k (hH − hL ) hL ] + m(1 − a )2 (1 − k) bH
2
− (bH − bL ) kbL
leading to profit

 
(1 − k) h2H − k (hH − hL ) hL (1 − k) bH2
pHC = (1 − k) hH vH − (hH − hL ) vL + k − c + m(1 − a )2 (1 − k) − k ( b H − bL ) b L .
2 2
(9)

hH vH
The condition hH vH > bH rHC is satisfied since 2 m
bH
> (1 − a) (1 − k). The low quality firm’s decisions are wLC = kkhL , rLC =
m(1 − a)kbL , and pLC = hL (vL + kkhL ) + mk(1 − a )2 bL2 leading to profit

m(1 − a )2 k2 bL2
pLC = k [hL (vL + kkhL ) − c] + . (10)
2

hL vL
Again the condition hL vL > bL rLC is satisfied since
bL2 m
> (1 − a) k and the high quality firm covers the market instead of
2 2 2

−k (1−k) hH −(1−k)k(hH −hL )hL −k hL (see Eq. (22)). Comparing with its
serving only the highs if pHM ≥ pHC which simplifies to Dv ≤ Dv 2
decisions under monopoly above, we have w = w , r = rH but pHC < pH (v = vH ). Similarly, comparing decisions of the low
HC H HC

quality firm under monopoly and competition, we have rLC < rM , and pLC < pM (v = vL ). Further, rLC ≥ rHC simplifies to Eq. (5).

A.3. Government subsidies for CSR

When the government provides a subsidy s(r) to a firm choosing a level r of CSR, the cost of CSR for the firm is given by C(r) =
r2 /(2m)−s(r). Considering a simple linear subsidy s(r) = sr where s ∈ [0, 1) ≥ 0 first under a monopoly, the optimal CSR and price
when DuL < 0 ≤ DuH , i.e., D = 1−k, are respectively: rHG = m[s+(1−a)(1−k)bH ], pHG = hH v+m(1−a)bH [s+(1−a)(1−k)bH ].
The resulting profit is

pHG = (1 − k) (hH v − c) + m[s + (1 − a ) (1 − k) bH ]2 /2. (11)

Comparing with the firm decisions shown under Proposition 1, we can see that rHG ≥ rH , pHG ≥ pH and pHG ≥ pH . Further, the
condition hH v > bH rH implies s < bhH m
v
− (1 − a ) (1 − k) bH . Similarly when n DuL ≥ 0, i.e., D = 1, we get rMG = m[s+(1−a)bL ],
H
and pMG = hL v + m(1 − a)bL [s + (1 − a)bL ] leading to profit

pMG = hL v − c + m[s + (1 − a ) bL ]2 /2. (12)

Again, comparing with Proposition 1, we have rMG ≥ rM , pMG ≥ pM and  pMG ≥ pM . The condition hL v > bL rM implies  s ≤
hL v hL v hH v
b m − ( 1 − a ) b L . Combining, the model requires s < s̄ where s̄ = min b m − ( 1 − a ) b L , b m − ( 1 − a ) (1 − k ) b H .
L L H
Further, pHG ≥ pMG if [(1 − k)hH − hL ]v + kc ≥ m[[s + (1 − a)bL ]2 − [s + (1 − a)(1 − k)bH ]2 ]/2 which leads to analogous results
as Proposition 1 with the only change being the threshold v̂G instead of v̂ where

 
m [s + (1 − a ) bL ]2 − [s + (1 − a ) (1 − k) bH ]2 2 − kc
v̂G = . (13)
(1 − k) hH − hL

In a duopoly, the decisions of a high quality firm which serves the entire market by preventing a low quality firm to sell its
2
rH
product are given by max pH − c − 2m + srH subject to pH − c ≤ hL vH + (1 − a)bL rH . Solving, we get rHMG = m[s + (1 − a)bL ], and
pH ,,rH
pHMG = hL Dv + c + m(1 − a)bL [s + (1 − a)bL ] leading to profit

m[s + (1 − a ) bL ]2
pHMG = hL Dv + . (14)
2

Similarly, the decisions of a high quality firm which serves only the highs allowing a low quality firm serving only the lows are
2
rH
given by max (pH − c) (1 − k) − 2m + srH subject to pH − pL ≤ hH Dv + (1 − a)bH Dr. Simultaneously the low quality firm solves
pH ,rH
744 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745

r2
max (pL − c) k − 2m
L
+ srL subject to pL ≤ hL vL + (1 − a)bL rL . The high quality firm’s decisions are: rHCG = m[s + (1 − a)(1 − k)bH ],
pL ,,rL
 
and pHCG = hH vH − (hH − hL ) vL + m (1 − a ) [(1 − a ) (1 − k) bH 2
− (bH − bL ) kbL + sbL ] leading to profits

   
m 2 (1 − k)bH
2
s
pHCG = (1 − k) (hH vH − (hH − hL ) vL − c) + (1 − a) (1 − k) − k (bH − bL ) bL + s + (1 − a)(1 − k)bL .
2 2 2
(15)

We can see that pHMG ≥ pHCG if Dv ≤ Dv

G where
 
b2 −(1−k)2 bH
2
m(1 − a) (1 − a) L 2 + kbL [s + (1 − a)(1 − k) (bH − bL )] − (1 − k) (hL vL − c)

G =
Dv . (16)
(1 − k)hH − hL

A.4. Proof of Propositions

Proof of Proposition 1. The firm’s decision problem when DuL < 0 ≤ DuH , i.e., D = 1 − k is given by max p s.t. p ≤
p,,r
2
hH v + (1 − a)bH r. Solving, we get r = m(1 − a)(1 − k)bH , p = hH v + m(1 − a ) (1 − k)
H H 2
bH , and the resulting profit 15

pH = (1 − k) (hH v − c) + m(1 − a )2 (1 − k)2 bH

2
/2. (17)

When DuL ≥ 0, i.e., D = 1, the firm’s decision max p s.t. p ≤ hL v + (1 − a)bL r solves as rM = m(1 − a)bL , and pM =
p,,r
hL v + m(1 − a)2 b2L leading to profit16

pM = hL v − c + m(1 − a )2 bL2 /2. (18)

1−k h 1−k b 1−k h 1−k b 1−k h 1−k b

Three possible conditions arise : a) ( h ) H > ( b ) H ≥ 1, b) ( h ) H > 1 > ( b ) H , and c) 1 ≥ ( h ) H > ( b ) H . First
L L L L L L
considering a) and denoting, DpHL = pH − pL , we can see that DpHL ≥ 0 is trivially satisfied implying r∗ = rH and p∗ = pH . Under
b) DpHL ≥ 0 is satisfied only if v ≥ v̂ (see Eq. (4)) implying r∗ = rH and p∗ = pH when ∗ H ∗ H ∗
 r = r , and p = p and r = r and
M
∗ 2 2 2
p = p otherwise. Notice that v ≥ v̂ is trivially satisfied if c ≥ ĉ where ĉ = m(1 − a ) bL − (1 − k) bH / (2k). Comparing, we
M 2

can see that rH < rM because bL > (1 − k)bH and pH > pM . And finally, under c) DpHL ≥ 0 is satisfied only if v ≤ v̂, a necessary
condition for which is c ≥ ĉ. Again, comparing CSR and prices, we can see that rH < rM and pH > pM . 

Proof of Proposition 2. Consider first the high quality firm, which serves the entire market pushing the low quality firm to
2
rH
charge a price at marginal cost c resulting in rL = 0 because it earns no profit. Solving max pH − c − 2m subject to pH − c ≤
pH ,rH
2 2
hL Dv + (1 − a)bL rH . Solving, we get r HM
= m(1 − a) bL , and p HM
= hL Dv + c + m(1 − a ) bL leading to profit

m(1 − a )2 bL2
pHM = hL Dv + . (19)
2

Comparing with results of Proposition 1, we have rHM = rM , pHM ≤ pM (v = vH ) since c ≤ hL vL and pHM ≤ pM (v = vH ).
Now consider the high quality firm which serves only the highs facing a low quality firm serving only the lows. Solving
2
rH rL2
max (pH − c) (1 − k) − 2m subject to pH − pL ≤ hH Dv + (1 − a)bH Dr simultaneously with max (pL − c) k − 2m subject to pL ≤
pH ,rH pL ,rL
2 2
hL vL + (1 − a)bL rL . The low quality firm’s decisions are rLC = m(1 − a)kbL , and pLC = hL vL + mk(1 − a ) bL leading to profit

m(1 − a )2 k2 bL2
pLC = k (hL vL − c) + . (20)
2
hL vL
Again the condition hL vL > bL rLC is satisfied since
bL2 m
> (1 − a) k. Simultaneously solving the high quality firm’s decisions, we
 
get r HC
= m(1 − a)(1 − k)bH , and p HC
= hH Dv + hL vL + m(1 − a )2 (1 − k) bH
2
− k (bH − bL ) bL leading to profit

(1 − k) bH2
pHC = (1 − k) [hH Dv + hL vL − c] + m(1 − a )2 (1 − k) − k (bH − bL ) bL . (21)
2

hH v
15
Note that the condition hH v > bH rH implies bH m > (1 − a) (1 − k) is satisfied since hH > bH and v > m.
hL v
16 M
The condition hL v > bL r implies bL m > 1 − a is satisfied since hL > bL and v > m.
 S. Banerjee, L. Wathieu / International Journal of Research in Marketing 34 (2017) 734–745 745

hH vH
The condition hH vH > bH rHC is satisfied since 2 m
bH
> (1 − a) (1 − k).

where17
The high quality firm covers the market instead of serving only the highs if pHM ≥ pHC which simplifies to Dv ≤ Dv
 
bL2 −(1−k)2 bH
2
m (1 − a )2 2 + k (1 − k) (bH − bL ) bL − (1 − k) (hL vL − c)

=
Dv . (22)
(1 − k) hH − hL

Comparing with its decisions of a high quality monopolist (see Proof of Proposition 1), we have rHC = rH but pHC < pH (v = vH ).
Similarly, comparing decisions of the low quality firm under monopoly and competition, we have rLC < rL , and pLC < pL (v =
vL ). Further, rLC ≥ rHC simplifies to Eq. (5). 

Appendix B. Supplementary data

Supplementary data to this article can be found online at http://dx.doi.org/10.1016/j.ijresmar.2017.06.006.

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17
= v̂ + m(1−a )2 k(1−k)(bH −bL )bL −(1−k)hL vL +c
Note that Eq. (22) can also be expressed as Dv (1−k)hH −hL .