Abstract: Firms invest in services to attract new customers and to keep existing ones. However, it is not clear whether service expenses will improve firm profitability. Through analytical modeling, the impact of market factors on firm value in a competitive market is investigated in this paper. A deterministic demand model that captures two firms' pricing and service competition is employed and the degree of product differentiation and market concentration is incorporated. Firms' optimal decisions are compared in three scenarios: (Ⅰ) firms engage in price competition and neither invests in customer service; (Ⅱ) One firm makes decision on price and service investment and the other only on price; (Ⅲ) Both firms make price and service investment decisions simultaneously. By comparing the equilibrium profits across the three scenarios, it can be found that in equilibrium, both firms invest in customer service. In particular, the value of service expenses increases with the degree of product differentiation, and the firm's market share. That is, in a market featuring high product differentiation, service expenses will bring higher value to the firm. And in a highly concentrated market, service expenditure is more likely to create higher value for the firm with a larger market share.

Key words: service expenses, product differentiation, market concentration