Penetration or skimming pricing for credence products?

Abstract

This paper investigates a dynamic model of price signaling for a credence product with unknown social performance. A new entrant uses prices to reveal social responsibility and maintain reputation during a verification phase. In equilibrium, the signaling strategy involves penetration or skimming pricing depending on the competitive pressures the entrant faces. Faced with competition from conventional incumbents, the socially responsible entrant repeatedly charges low prices to penetrate the market. In contrast, in an untapped market, the socially responsible entrant repeatedly charges high prices to skim the cream off the top of the demand. In both cases, costly signaling is consistent with Veblen's law that conspicuous waste is an effective signal of reputation.