The Impact of Capital Constraints on Service and Price Competition

A retailer’s capital constraints not only influence its own operations but also significantly affect the operational decisions of its competitors. This study focuses on two competing retailers selling homogeneous products in the same market, who engage in both service-level and retail-price competition. When a retailer faces a capital constraint, it resorts to external financing. The core objective is to analyze how capital constraints affect competitive dynamics and profitability. The findings reveal that under mild capital constraints, profits may be higher than when retailers have ample capital. Additionally, when one retailer is capital-constrained and the interest rate is high, the constrained retailer with smaller potential market demand may set a higher retail price than its larger rival, depending on the service cost coefficient. Moreover, when the larger retailer suffers a severe capital constraint, the smaller retailer can achieve a profit advantage: if the small retailer is well-funded, it does so by raising its service and price; if the small retailer is also mildly constrained but much better off than the larger rival, it does so by keeping low service and low price and relying on its cost advantage.