Opaque Selling with Endogenous Product Characteristics

Abstract

This paper explores the profitability and impact of opaque selling in a monopolist market with endogenous product characteristics. Opaque selling is a strategy where a firm sells goods through a lottery mechanism that randomly rewards consumers with a product that is revealed after purchase. Using a standard two-good Hotelling model with endogenous product locations, I compare market equilibria for a monopolist under traditional selling and opaque selling. I find that opaque selling always earns the firm a higher profit when product locations are endogenous. Additionally, it generally induces the firm to select more extreme product varieties. Using an extension to the Salop circular city model, I also show that opaque selling results in the firm introducing fewer product varieties. In terms of welfare, opaque selling unambiguously increases producer surplus and reduces consumer surplus. Although consumption of the lottery good is welfare inefficient, opaque selling can potentially increase welfare by inducing the firm to serve more consumers than it would under traditional selling. These results suggest that opaque selling may be a more viable long-term strategy when firms are capable of adjusting their product mix.