Summary

The business environment today is characterized by increasing product variety and diversity in consumer taste. Successful product differentiation brings a firm profit as it helps the firms better cater to consumer wishes. Quality is often the most distinct characteristic which differentiates a product from others. A product with better quality is more attractive to consumers, who are willing to pay more for a better quality. Therefore, an effective differentiation strategy of a firm is to provide a better version of an existing product in terms of quality. We refer to this quality upgrade as a next-generation product (NGP). An example of a NGP is the Intel Core i7 relative to the Intel Core i5, where the new faster generation of processor is more attractive to most consumers. The improvements in a NGP can be incremental advances or major breakthroughs. Successive generations of a product can also be introduced by different firms and the firm which satisfies consumer needs at the right time can detract the market from the competitors. An example is Apple’s first iPod versus the more primitive players introduced by Creative Technologies, where the iPod was an expensive high-end product, giving consumers more storage. With the success of the iPod, Apple grew to 80% market share in music players.

A NGP launch is a challenging and complex process. A detailed study of 28 NGP projects at 14 leading high-tech companies shows that only four successfully met their developers’ market-share aspirations (Tabrizi and Walleigh, 1996). Although consumers always desire a better product, a NGP directly compete against a firm’s own existing product and it cannibalizes the old product, starting at the high end of the market and diffusing downward. The success of a NGP depends on its quality and whether there are enough consumers who appreciate a better-quality good and are willing to pay a sufficiently higher price. On the one hand, quality can only be improved over time and consumer taste is highly uncertain till the very late stage of a new product development project. On the other hand, a late product launch can lead to lost sales. Research of Cohen et al. (1996) shows that companies can lose 33% profit when they ship products six months late. Therefore, the investment timing and how much capacity to build is of critical importance to firms during a NGP launch.

In this research project, we investigate two main capacity decisions of competing firms during a NGP launch: (1) when to build capacity for the NGP? And (2) what is the optimal allocation of the total available capacity between the two products? The first question asks a firm to balance the risks of premature entry (investing too early) and the problem of missed opportunities (investing too late). Since the second capacity question is essentially a capacity mix problem. Different from a standard product portfolio problem, a capacity mix problem asks a firm to divide a single resource among different products. Here the trade-off is internal: one more unit capacity of the NGP means one less unit capacity available to the existing product. For instance, during the launch of a new iPhone series, Apple gradually changes the existing production lines that are used for previous iPhone series into manufacturing the new series. Eventually, Apple discontinues the aging series. As pricing strategies depend on the available capacity of each product in the portfolio, the capacity mix problem directly decides a firm’s total profit.

To answer these two questions, we develop economics models and derive the optimal equilibrium strategies for competing firms. Our research findings generate new insights for a firm’s NGP launch strategy under competition. First of all, firms should characterize a target market by measuring the following two indexes: the average consumer taste and the heterogeneity/homogeneity in consumer taste. A high level of consumer taste heterogeneity indicates that many consumers will switch from purchasing the existing product to purchasing the NGP, while a high average consumer taste indicates high prices for both the existing product and the NGP. When there exists uncertainty in consumer tastes and thus these two indexes are stochastic, our results show that firms should evaluate the exposure to demand risk, which is measured by the correlation between the average consumer taste and the heterogeneity/homogeneity in consumer taste. A strong correlation indicates a high exposure to demand risk and large impact of demand risk on firms. Intuitively, firms should postpone their investments until the uncertainty is resolved if the exposure to demand risk is high. However, in the competition, a firm may hold a cost advantage over its competitor and our results show that when a firm’s cost advantage exceeds a specific threshold, it can use this cost advantage to mitigate the impact of demand risk and thus invest earlier than its competitor. We develop three evaluation criteria, which use different market data, to determine a firm’s optimal investment strategy under all possible situations. Therefore, a firm can select the suitable criterion based on its available data, and use this criterion for decision making. Based on our results, we also present a flowchart to guide investment decisions in a NGP launch under competition.

Selected publications

Xishu Li, Rob Zuidwijk, M.B.M. de Koster. 2018. Launching Next-Generation Products in a Competitive Market. (working paper)

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