Article

Durable-Goods Monopoly with Endogenous Innovation

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Abstract

While selling an existing product, a durable-goods monopolist may develop a new, improved product. The firm must consider the interaction between its intertemporal pricing and research and development (R&D) decisions. The interactions show a sharp dichotomy depending on pricing regimes. When it is optimal for the firm to continue to sell the old model along with the new model, the interactions disappear. However, when it is optimal for the firm to discontinue the sale of the old model after introducing the new model, the firm will face a time-inconsistency problem in its R&D decision. Copyright 2004 Blackwell Publishing, 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington Road, Oxford OX4 2DQ, UK..

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... We then consider the work of Zhang (2005) on endogenous product lines in a Hotelling-style duopoly model of horizontal differentiation. Finally we discuss the papers of Levinthal and Purohit (1989), Waldman (1996), and Nahm (2004) on the introduction of a new product in models with anonymous consumers and a frictionless second-hand market. ...
... We focus on these two sorts of models, and do not discuss the related literature on the monopolist's profit-maximizing menu of goods and prices in a static model. 32 We do however discuss the papers of Levinthal and Purohit (1989), Waldman (1996), andNahm (2004), which study the introduction of a new product in models with anonymous consumers and a frictionless second-hand market. Although behavior-based pricing is not 30 His model is an extension of Doganoglu and Grzybowski (2004) who consider the same preferences but without price discrimination. ...
... Waldman (1996) and Nahm (2004) analyze endogenous innovation in the anonymous case. Waldman suppose that there are only two types, L θ and H θ , with LLL Vc θ < . ...
... In a similar setting with a partly-covered installed base and where the new product is sold for only one period, previous research has variously found (or sometimes assumed) that the vendor would always sell the new product to high valuation consumers when there exists a frictionless second hand market and the demand is continuous. Whether the vendor would continue to sell the old product to low valuation consumers depends on demand distributions and the relative quality of the old and new products (Levinthal and Purohit 1989; Fudenberg and Tirole 1998; Kornish 2001; Nahm 2004; Sankaranarayanan 2007). In view of these findings, we ask two questions: Suppose that there is no second hand market and so consumers cannot resell their old products, and, the vendor can plan for both the old and new products over two periods (instead of one) with high type consumers already owning the old product. ...
... there is only a small set of parameters in which strategies S2 and S3 could be optimal for the vendor. These results imply that the common finding (or assumption), that the vendor would always sell the new product immediately only to some high type consumers (Levinthal and Purohit 1989; Fudenberg and Tirole 1998; Kornish 2001; Nahm 2004), is often not tenable. Further, on the condition that high type consumers own the old product prior to the beginning of the game, strategies such as " simultaneous introduction " (sell the old and new products in Period 1 to different consumers) or " sequential introduction " (sell the new product in Period 1 to high types and old product in Period 2 to low types) (Moorthy and Png 1992) which had received some attention in the literature may not be likely equilibrium outcomes. ...
... ould reduce their need to buy the new product in Period 2. Overall, if the vendor has an option to sell the new product later, it is difficult for it to restrict output to only high types or practice static price discrimination using different products in Period 1 (despite high type consumers own the old product prior to the beginning of the game). Nahm 2004), allowed the vendor to extend the decision horizon to beyond one period after the new product is introduced, and did not pre-set product sequences (cf. Moorthy and Png 1992; Dhebar 1994; Kornish 2001). All of these points of departure are not unrealistic, but yet they lead to results that are distinctive from the previous literature. ...
Article
This paper studies a vendor's timing and pricing of a new product in the presence of an installed base. Using a stylized model with overlapping generations of a durable product and heterogeneous consumers, we show that the valuation of former patrons toward the new product is dynamic over time. Together with new customers who do not own the old product, such dynamic valuation leads to a demand structure that is more heterogeneous than those studied in the prior literature. We found that the vendor would often prefer intertemporal but not static price discrimination in maximizing its profits. Surprisingly, such intertemporal price discrimination is sometimes perfect in the sense that the vendor may capture all surplus from consumers. We also show that the vendor would at times delay selling the new product so as to overcome the negative influences caused by time inconsistency and cannibalization. Overall, we found that the vendor's equilibrium choices often result in socially inefficient outcomes, and upgrade pricing may not rectify such inefficiencies. In fact, the vendor may even forgo using upgrade pricing in equilibrium. Hence, direct price discrimination based on purchase history may lose its merit when a vendor dynamically prices a new product in view of an installed base of old products.
... 5 Intertemporal product line and pricing studies have typically found that consumers with higher valuations would buy a product first. See, for example, Stokey (1979), Besanko and Winston (1990), Moorthy and Png (1992), Waldman (1996b), Fudenberg and Tirole (1998), Lee andLee (1998), andNahm (2004). ...
... In a similar setting with a partly-covered installed base and where the new product is sold for only one period, previous research has variously found (or sometimes assumed) that the vendor would always sell the new product to high valuation consumers when there exists a frictionless second hand market and the demand is continuous. Whether the vendor would continue to sell the old product to low valuation consumers depends on demand distributions and the relative quality of the old and new products ( Levinthal and Purohit 1989;Fudenberg and Tirole 1998;Kornish 2001;Nahm 2004;Sankaranarayanan 2007). ...
... Proposition 2 shows the importance of game structure in shaping previous findingsour model departs from previous studies in that we removed the assumption of the existence of a frictionless second hand market (cf. Levinthal and Purohit 1989;Fudenberg and Tirole 1998;Nahm 2004), allowed the vendor to extend the decision horizon to beyond one period after the new product is introduced, and did not pre-set product sequences (cf. Moorthy and Png 1992;Dhebar 1994;Kornish 2001). ...
Article
We provide an explanation for tying not based on any of the standard arguments: efficiency, price discrimination, or exclusion. In our analysis a monopolist ties a complementary good to its monopolized good, but consumers do not use the tied good. The tie is profitable because it shifts profits from a complementary good rival to the monopolist. We show such tying is socially inefficient, but arises only when the tie is socially efficient in the absence of the rival. We relate this form of tying to several examples, discuss how it can also arise under competition, and explore its antitrust implications. (JEL D42, K21, L12, L25, L40)
... After the first period, brands can invest in product and service innovation to develop an improved product. The outcome of product and service innovation is uncertain (Iyer & Soberman, 2016;Nahm, 2004;Zhang, 2016). If a brand's innovation is successful, the brand sells the improved product in the second period. ...
... Brands can invest in R&D for product and service innovation. The outcome of innovation is uncertain (Zhang, 2016;Nahm, 2004). If successful, the brand sells an improved product with value r + d in the second period, where d > 0 represents the degree of value improvement. ...
Article
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Product and service innovation is important for brands to succeed in a competitive marketplace. As information technology advances, customer recognition becomes a growing industry trend; that is, brands track customers' purchase history, recognize and price discriminate between repeat and new customers.The trend of customer recognition has changed the nature and intensity of competition between brands. In this article, we examine how customer recognition and the associated changes in competition affect brands' incentives to invest in product and service innovation. We find that when brands have similar equity, customer recognition increases brands' incentives to invest in product and service innovation. However, when brands have sufficiently different equity, customer recognition leads the stronger brand to invest more and the weaker brand to invest less in product and service innovation. In addition, extant literature suggests that customer recognition reduces brand profits. In contrast, we find that customer recognition can increase the weaker brand's profit but decreases it more for the stronger brand. Thus, collecting customers' purchase history data for customer recognition can be beneficial for weaker brands but detrimental for stronger brands.
... Throughout the paper, we focused on whether the firm benefits from making products obsolete through low durability, i.e., planned obsolescence. However the firm may use another form of obsolescence – technological obsolescence, whereby it innovates and introduces improved versions of the product (Waldman 1993, 1996, Fishman and Rob 2000, Nahm 2004). New and improved products make the existing products owned by consumers technologically inferior, inducing them to replace the old products, and increasing the firm's profits. ...
... Articles in the academic literature and the business press have long argued for the benefits of a planned obsolescence strategy, where a firm designs a durable product to become obsolete after a certain period of use in order to induce consumers to make repeat purchases (Bulow 1986, Waldman 1996 Research has also discussed the benefits of technological obsolescence, where the firm introduces new and improved products to induce consumers to replace their existing products (Waldman 1993, Fishman et al. 1993, Waldman 1996, Fishman and Rob 2000, Nahm 2004). Moreover, the existing literature promotes both planned obsolescence and technological obsolescence and considers them to achieve the same goal, i.e., making old products less attractive and inducing replacement purchases (Waldman 2003). ...
Article
An extensive body of literature argues for the benefits of planned obsolescence, where a firm designs products with low durability to induce repeat purchases from the consumers. Yet, several firms avoid planned obsolescence and instead offer products with high durability. In this paper, we offer a demand-side rationale for a high-durability product design strategy: exclusivity-seeking consumer behavior. In a market with consumers who value exclusivity, we find that firms benefit from designing products with higher durability in conjunction with a high-price, low-volume introduction strategy. A high price jointly exploits the value inherent in a more durable product and moderates the sales volume to achieve the product exclusivity valued by the market. This contrasts with the planned obsolescence strategy that capitalizes on the high sales volume achieved by setting a low new product price. Our analysis also unearths insights regarding the effect of exclusivity-seeking behavior on a firm's demand and pricing. We show that firms' durability choice may explain the joint increase in price and demand in markets for conspicuous goods. We also show that even in the absence of a positive correlation between consumer valuations and sensitivity to exclusivity, consumers who are more sensitive may not buy used products in equilibrium.
... However, all these works abstract away from Coasian effects assuming either non-overlapping cohorts of homogeneous consumers or high heterogeneity (in Waldman (1996) there is only one "type" whose valuation exceeds the marginal cost of production). Fudenberg and Tirole (1998) and Nahm (2004) relax the assumption of homogeneous consumers and present a two period model of technological innovation in which a seller introduces an improved product in period 2. However in Fudenberg and Tirole (1998) technological progress is exogenously given. Nahm (2004) explores a related dynamic tradeoff focusing on its implications in terms of time consistency of R&D choices. ...
... Fudenberg and Tirole (1998) and Nahm (2004) relax the assumption of homogeneous consumers and present a two period model of technological innovation in which a seller introduces an improved product in period 2. However in Fudenberg and Tirole (1998) technological progress is exogenously given. Nahm (2004) explores a related dynamic tradeoff focusing on its implications in terms of time consistency of R&D choices. He also obtains a "separation result". ...
Article
"Destructive Creation" is the deliberate introduction of new, perhaps improved generations of durable goods that destroy, directly or indirectly, the usage value of units previously sold inducing consumers to repeat their purchase. This paper discusses this practice by a single seller in an infinite-horizon, discrete time model with heterogeneous consumers. Despite the lack of commitment power over future prices and introduction policies, this practice restores partially or totally market power even though consumers anticipate opportunistic behavior. However, the monopoly resorts "too much" to this mechanism from an ex-ante, profit maximizing perspective. High prices in earlier periods allow the seller to commit to defer innovation and therefore to maintain buyers' confidence over "durability". The paper characterizes the equilibrium properties of the resulting innovation cycles such as existence, uniqueness and asymptotic stability and discusses potential regulatory remedies in those instances where destructive creation generates economic inefficiencies. This theory applies, among others, to markets characterized by network externalities, compatibility issues, standard setting, social consumption and signal provision and may help explain many restrictive aftermarket practices as well as excessive add-on pricing without relying on any leverage hypothesis.
... via the regulators. rectly reducing its durability by introducing new versions of the product (Waldman, 1993;Choi, 1994;Utaka, 2006;Iizuka, 2007;Utaka, 2022) or by improving the quality of the product in future sales (Waldman, 1996;Lee and Lee, 1998;Nahm, 2004). Many of the aforementioned studies argue that monopolists end up producing products with a socially inefficient level of durability. ...
Preprint
Full-text available
We consider a two-period model where a durable-goods monopolist might engage in "dynamic obsolescence" by changing the durability of the good in period 2 from what was planned in period 1 (e.g. through software updates) after consumers have bought it. We show that given the opportunity to do so, in the subgame perfect Nash equilibrium of the game the monopolist chooses to reduce the durability in the second period. Moreover, we show that if the monopolist commits to a durability level (i.e. use planned obsolescence), then he achieves a higher profit compared to the case of dynamic adjustment of durability.
... This result arises when avoiding cannibalization is more important in their setting than price discrimination. The literature on planned obsolescence in which renting is used to avoid time inconsistency concerning new product introductions such as Waldman (1993Waldman ( , 1996, Choi (1994) and Nahm (2004) is also closely related. We contribute to this literature by showing how the desire to limit cannibalization can affect the internal organization of the firm. ...
... A careful timing of the new releases allows the company to control the perceived obsolescence of its product range and thus "drive people to upgrade" without incurring the risks associated with a dual rollover. For example, the market typically perceives existing versions of EA Inc's FIFA sports games as obsolete once a new version has been released, even though the previous versions are not outdated in objective terms (Cooper 2004, Nahm 2004, Koenigsberg et al. 2011. Likewise, in the well-documented "slow iPhone phenomenon", users experienced a perceived slowdown of old iPhone versions precisely when a new version was released (Richter 2016). ...
... Researchers have investigated the problem of replacement timing of durable goods both from normative (Nahm, 2004;Zhao and Jagpal, 2006;Fernandez, 2000) and behavioral perspectives (Okada, 2001;Cooper, 2004;Cripps and Meyer, 1994;Grewal, Mehta and Kardes, 2004). Normative models assume that consumers maximize their net utility of ownership over a relevant time horizon incorporating the relative net expected utilities from the old and new products, the product depreciation rates and inter-temporal discount rates (Padmanabhan and Bass, 1993;Rust, 1987). ...
... Researchers have investigated the problem of replacement timing of durable goods both from normative (Nahm, 2004;Zhao and Jagpal, 2006;Fernandez, 2000) and behavioral perspectives (Okada, 2001;Cooper, 2004;Cripps and Meyer, 1994;Grewal, Mehta and Kardes, 2004). Normative models assume that consumers maximize their net utility of ownership over a relevant time horizon incorporating the relative net expected utilities from the old and new products, the product depreciation rates and inter-temporal discount rates (Padmanabhan and Bass, 1993;Rust, 1987). ...
Article
Purpose Unlike point of purchase behavior, not much is known about how payment method impacts post-purchase behavior, especially for durable goods where user experience can last over long periods. The purpose of this paper is to link two strands of literature for the first time by uncovering systematic linkages between the payment method (upfront cash vs loan) used for purchase of durable goods and the replacement timings for the same. Design/methodology/approach The authors predict that cash purchases are more likely to have shorter replacement horizons compared to loan purchases and propose a psychological mechanism that accounts for the same. Their arguments are based on how the strength of coupling, which is the degree of psychological association between payment and consumption, depends on the payment method and differentially influences the consumption experience and consequently leads to different replacement horizons. They conduct a field study to test their predictions and find support for their model. Findings The authors find that individuals who financed their durable goods purchases using loan, expressed their intentions to replace the goods after longer period than those who financed their durable goods with cash down payment. As loan installments remind people of painful thoughts of payment, they tend to reduce the dissonance by positively evaluating both retrospective and anticipated usage experiences. This dissonance reduction mechanism eventually leads to reduced willingness to let go of the durable. Practical implications Marketers are faced with a tradeoff between increasing purchase likelihood versus ensuring long-term post-purchase satisfaction. In this paper, the authors uncover the psychological mechanisms that can explain how payment method chosen to pay for a durable can have direct effect on post-purchase consumption experiences and subsequently in the replacement intentions. This finding is crucial for marketers who are interested in planning the product line launches and other post-purchase engagement strategies such as buy-back scheme and upgrades. Social implications Understanding the psychological mechanisms that explain individual’s likelihood to replace their durable goods allows policymakers to design appropriate interventions to induce more sustainable and efficient use of durable goods in the market. While on one hand, marketers might be interested in increasing sales of their product line by inducing faster replacement of older product versions, environmentalists nudge towards the opposite. This paper provides a possible way to achieve the dual objectives. Originality/value While past research on downstream effects of payment methods on behavioral outcomes focused only on consumables, the authors focus on durable goods. Further, they identify the effect of payment method on both psychological and behavioral outcomes.
... See for instanceWaldman (1993),Fudenberg and Tirole (1998) andNahm (2004); we adapt the framework ofFudenberg and Tirole (1998) to the case of tempted consumers.14 This is approximated with the formulation ofLaibson (1997), used by O'Donoghue and Rabin (1999) and others.15 ...
Working Paper
Consumers may purchase durable goods on the basis of short-term "temptation," as well as their long-term interests. I adapt Gul and Pesendorfer's (2001) representation of self-control preferences to a market for durable goods. Consumers' temptation will increase profit, and can ameliorate a monopoly seller's own time-inconsistency problem. A low degree of temptation will hurt consumers and decrease total surplus in the market, but high enough temptation will augment consumer and total surplus.
... The research question in this paper is related to that in Daughety and Reinganum (2008) and Janssen and Roy (2014) who study the trade-off between disclosure and signaling of current product quality. These papers show that product disclosure by high-quality firms can be a way to avoid the constraint of having to distinguish oneself from a low-quality type and, in Janssen and 10 See, for instance Fishman and Rob (2000), Nahm (2004), and especially Waldman (1996) on monopoly. Deneckere and De Palma (1998) study this in an oligopoly framework. ...
... 7 Because consumers' willingness to pay for the current version depends on the value of holding that version in the second period, the marginal benefit from investing in innovation is different between the first 8 and second periods of that model. Nahm (2004) examines when same problem obtains in a setting similar to Fudenberg and Tirole's. Again, these works assumed that the outcome of any research and development was publicly known. ...
Article
Prices can credibly signal whether a durable-goods monopolist will offer an improved good in the future. When the future release of a new version is private information, a monopoly seller will reveal a failure to develop and market a new version with a lower price than he or she would charge in full information. A firm would be willing to pay more to innovate when consumers are uncertain than if they are informed ex ante because a failure to innovate is punished by a low equilibrium price. Consumers' uncertainty about innovation intensifies an unsuccessful innovator's Coasian problem and increases consumer welfare.
... In this sense, there exist two overlapping product generations available to D in the second period. 3 The latter argument is known sinceCoase (1972) and has more recently been studied in the context of innovation incentives byFishman and Rob (2000) orNahm (2004), for example. For a comprehensive ...
Article
This paper analyzes the impact of patent protection on upstream innovation incentives in a vertical industry with complementary inputs and consecutive invest-ment periods. We show that in case of fixed-order sequential bargaining between suppliers and a downstream firm, ironclad intellectual property rights lead to a complete breakdown of investments into components due to hold-up problems, despite full bargaining power of the investing parties. Knowledge diffusion that allows the downstream firm to buy an older version of the component at a cheaper price in later periods is thus beneficial for all firms. Allowing for a stochastic bargaining sequence alleviates the complete hold-up under patent protection. Yet, upstream innovation might still be higher under knowledge diffusion.
... Researchers have investigated the problem of replacement timing of durable goods both from normative (Nahm, 2004;Zhao and Jagpal, 2006;Fernandez, 2000) and behavioral perspectives (Okada, 2001;Cooper, 2004;Cripps and Meyer, 1994;Grewal, Mehta and Kardes, 2004). Normative models assume that consumers maximize their net utility of ownership over a relevant time horizon incorporating the relative net expected utilities from the old and new products, the product depreciation rates and inter-temporal discount rates (Padmanabhan and Bass, 1993;Rust, 1987). ...
Article
Replacement timing decisions of durable goods have been studied by scholars from both normative and descriptive perspectives. Normative models are based on the optimization of some utility based objective function which then suggest an optimal time for replacing a durable good. On the other hand, studies by behavioral researchers using simulated lab-experiments show that individuals do not always make optimal replacement decisions but instead exhibit deviations in systematic ways. For example, individuals were observed to replace old durables at a slower rate than that predicted by normative models and seemed to anchor on some mental threshold for making replacement decisions.The present study adds to the literature on replacement decisions by uncovering systematic linkages between different payment methods at the time of purchase of durable goods and the replacement timing of the same. We also explore the psychological processes underlying these systematic effects. We start by proposing a behavioral model that draws on findings from the mental accounting, coupling effects and cognitive dissonance literatures to predict that people who make cash purchases are more likely to replace the durable earlier compared to people who make the purchase through loans and make EMI payments.Our arguments are based on how payment methods (cash or EMI) influence the consumption experiences of durable goods, which ultimately impacts the replacement time. We propose that the strength of coupling, which is the degree of association between payment and consumption instances, depends on different payment methods and differentially influences the motivation of individuals to close their mental accounts on one hand and the consumption experiences due to cognitive dissonance effects on the other.We conduct two lab and one field experiment to test our model predictions and find support for the same.
... Fudenberg and Tirole (1998) make a comprehensive analysis of monopoly pricing of durable goods in cases where the monopolist can introduce new versions with higher quality, although they do not consider the R&D decision. See also Lee and Lee (1998), Kumar (2002), and Nahm (2004) for the monopolist's strategy concerning new product introductions. About the strategies of durable-goods producers when there is asymmetric information, see Hendel and Lizzeri (2002), Johnson and Waldman (2003), and Utaka (2006b, 2008). ...
Article
By using a durable-goods monopolist model, this paper investigates the timing of upgrades. I consider a three-period model where the monopolist can upgrade the product in the second and third periods by investing in R&D. I analyse the non-commitment and commitment cases. In the latter case, the decision on the timing of upgrades is made in the first period in advance. It is shown that the time-inconsistency problem causes the monopolist in the non-commitment case to release a new version more rapidly than in the commitment case. Moreover, even in the non-commitment case, the release of a new version can still be later than the optimum from the social viewpoint.
... 24 A similar result is obtained in Fishman and Rob (2000), who focus on the physical obsolescence of durable goods, as opposed to the technological obsolescence considered in Waldman (1996) and our paper. Nahm (2004) points out that a monopolist's ability to practice planned obsolescence does not raise its investment level if it is optimal for the firm to continue to sell the old product along with the new one. However, in the software market we study here, it is more typical for a firm to discontinue the sale of the old product after introducing the new one and therefore Waldman's analysis seems more relevant. ...
Article
This paper examines the welfare implications of planned obsolescence in situations where the traditional monopoly undersupply exists. We find that the monopolist’s introduction of incompatibility between successive generations of products alleviates the monopoly undersupply problem and may therefore generate higher social welfare than compatibility. Paradoxically, the stronger the network effects, the more likely welfare will increase as a result of incompatibility. Our result also extends to two-sided markets characterized by indirect network effects.
... 15 A model such as ours can also be extended to a two-country framework, in order to contribute to the developing literature studying the role of multi-product firms in international trade (Brambilla, 2009;Fajgelbaum et al., 2009): an increasing β could then be perceived as a globalization shock, and one could study its effects on the contribution of quality leaders to the economic growth rate. Finally, our modeling approach can also prove itself a useful tool in the durable good literature: it can be considered as a way of endogenizing the R&D decision of the seller of a durable good (Fischman and Rob, 2000;Nahm, 2004). ...
Article
Our paper presents a new rationale for innovation by incumbents. We show that the possibility to price-discriminate between consumers having different levels of wealth is a sufficient incentive for the industry leader to overcome the Arrow (1962) effect and keep investing in R&D, even in the absence of any incumbent advantage in the R&D field. We model an economy composed of two distinct groups of consumers, differing in their wealth endowment and subject to non-homothetic preferences, obtained through unit consumption of the quality good. We demonstrate that in such a framework, there exists a unique steady state equilibrium with positive innovation rates of both incumbents and challengers. Beyond its novelty, this result then also allows us to analyze the effect of the extent of income inequalities on both the challenger and incumbent innovation rates, and by extension on the economic growth rate. We demonstrate that a higher share of the population being poor is detrimental to the rate of economic growth, while a redistribution of wealth from rich to poor consumers increases the challenger innovation rate and has ambiguous effects on the incumbent’s investment in R&D.
... t a commitment problem and consumer heterogeneity as the explanation of more frequent upgrade than socially optimal level. On the other hand,Fishman and Rob (2000) suggest that under the assumption a new product provides a technological base for the next generation of a good the monopolist's innovation is slow compared to the social planner's view.Nahm (2004) shows that selling the old good along with the new product can mitigate the planned obsolescence problem. The present paper differs from the above research by suggesting the durable good monopolist shift from a monopoly market to a competitive market. Most papers take the monopoly setting as a given and try to face a solution for the du ...
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Strategic decentralization, bargaining, and transfer pricing in supply chain efficiency
... The demand from …rst period 2 In particular, we avoid issues related to time inconsistency in product improvement and focus exclusively on intertemporal pricing. For literature related to issues in dynamic product imrovement in Coasian framework see Waldman (1996) and Nahm (2004). Bulow (1986) shows that Coase time inconsistency problem can be mitigated by reducing durability. ...
Article
In a durable good monopoly where consumers cannot observe quality prior to purchase and product improvement occurs exogenously over time, we show that uncertainty in quality may resolve the time inconsistency problem (even for low levels of product improvement). Higher dispersion in quality creates greater demand for future product by increasing the incentive of buyers with inferior quality realizations to repurchase and this, in turn, reduces the incentive of the seller to cut future price. For various levels of product improvement, we characterize the range of quality uncertainty for which the market equilibrium is identical to one where the monopolist can credibly precommit to future prices. We also show that the presence of quality uncertainty can lead to no trading in the primary good market.
... The second recent innovation I will describe is the recent emphasis on models concerning newproduct introductions such as found in Waldman (1993 Waldman ( ,1996b), Choi (1994) The other main issue that has been investigated here is planned obsolescence or equivalently time inconsistency concerning new-product introductions (see, for example, Waldman (1993 Waldman ( ,1996b), Choi (1994), Ellison and Fudenberg (2000), and Nahm (2004)). Earlier papers such as Swan (1972) and Bulow (1986) discuss the issue of planned obsolescence from the standpoint of durability choice, but as Bulow states " …planned obsolescence is much more than a matter of durability, it is also and perhaps primarily about how oftern a firm will introduce a new product and how compatible the new product will be with older versions… " (Bulow (1986), p. 747) The recent papers listed above follow Bulow's suggestion of defining planned obsolescence in terms of new-product introductions, and show how Coase's initial insight concerning output choice can be used to provide a theory of planned obsolescence. ...
Article
We provide an explanation for tying not based on any of the standard arguments: efficiency, price discrimination, or exclusion. In our analysis a monopolist ties a complementary good to its monopolized good, but consumers do not use the tied good. The tie is profitable because it shifts profits from a complementary good rival to the monopolist. We show such tying is socially inefficient, but arises only when the tie is socially efficient in the absence of the rival. We relate this form of tying to several examples, discuss how it can also arise under competition, and explore its antitrust implications. (JEL D42, K21, L12, L25, L40)
... Most subsequent work on the issue of excessive obsolescence uses this framework (e.g. Waldman 1993, Choi 1994, Waldman 1996, Ellison and Fudenberg 2000, and Nahm 2004. This paper proposes a theory of planned obsolescence based on repeated games rather than the time-inconsistency problem of Coase. ...
Article
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This paper develops the idea that obsolescence acts as an incentive device to provide quality for experience goods. The argument is that obsolescence affects the frequency at which consumers repurchase products and may punish producers for a lack of quality. A higher rate of obsolescence enables a firm to convince its consumers that it provides high quality. We identify a trade--off between quality and durability, implying that the two are substitutes. This leads to excessive obsolescence. The inefficiency is due to unobservability and not monopolistic distortions. The theory follows naturally from the theory of repeated games.
... There is a relatively small literature on upgrade models, with most of the work involving a …nite horizon. Waldman (1996) and Nahm (2004) each examine a two period model, focusing on the incentive to invest in quality growth and R&D time inconsistency. Fudenberg and Tirole (1998) examine a two-period model where consumers are heterogeneous and the period two (new) good renders the period one (old) good obsolete; Hoppe and Lee (2003) extend this model to allow entry. ...
Article
We examine an infinite horizon model of quality growth in a durable goods monopoly market. The monopolist generates new quality improvements over time and can sell any available qualities, in any desired bundles, at each point in time. Consumers are identical and for a quality improvement to have value the buyer must possess previous qualities: goods are upgrades. We find that the upgrade structure, quality growth, and the fact that consumers are always in the market can lead to an almost complete loss in market power for the seller even though all consumers are identical. This is true for all discount factors. We show that subgame perfect equilibrium payoffs for the seller range from capturing the full social surplus all the way down to capturing only the current flow value of each good and that each of these payoffs is realized in a Markov perfect equilibrium that follows the socially efficient allocation path. We also find that equilibria may be inefficient.
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In a market with a technology provider and two competing manufacturers, we examine the provider's technology introduction strategy and the manufacturers’ product rollover strategies. Our main results show that, first, the provider sells the new technology to both manufacturers in the case of small-level technology improvement, and sells to only one of them otherwise. Specifically, under the niche strategy (i.e., the provider sells the new technology to only one manufacturer), the provider sells the new technology to the low-quality manufacturer in the case of moderate-level technology improvement; otherwise, the provider sells to the high-quality manufacturer. Interestingly, the provider's profit may decrease with increased technology improvement. Second, the manufacturers will remove the old version of the product from the market when adopting the new technology, as long as the quality of the new version of the product exceeds a critical threshold. Finally, if the provider has a limited production capacity and can only satisfy the demand of one manufacturer, the provider sells the new technology to the low-quality manufacturer when the technology improvement is moderate; otherwise, the provider sells to the high-quality manufacturer.
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The Theory of Industrial Organization is the first primary text to treat the new industrial organization at the advanced-undergraduate and graduate level. Rigorously analytical and filled with exercises coded to indicate level of difficulty, it provides a unified and modern treatment of the field with accessible models that are simplified to highlight robust economic ideas while working at an intuitive level. To aid students at different levels, each chapter is divided into a main text and supplementary section containing more advanced material. Each chapter opens with elementary models and builds on this base to incorporate current research in a coherent synthesis. Tirole begins with a background discussion of the theory of the firm. In part I he develops the modern theory of monopoly, addressing single product and multi product pricing, static and intertemporal price discrimination, quality choice, reputation, and vertical restraints. In part II, Tirole takes up strategic interaction between firms, starting with a novel treatment of the Bertrand-Cournot interdependent pricing problem. He studies how capacity constraints, repeated interaction, product positioning, advertising, and asymmetric information affect competition or tacit collusion. He then develops topics having to do with long term competition, including barriers to entry, contestability, exit, and research and development. He concludes with a "game theory user's manual" and a section of review exercises.
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Durable-goods monopolists face special problems because the sale of their products creates a secondhand market not controlled by the monopolist. To the extent the monopolist is able to rent his product rather than sell it, or to make binding promises about his future production, such problems are ameliorated. Given the inability to do the above, the monopolist is led to producing goods less durable than those produced by either competitive firms or monopolist returns. A reverse Averch-Johnson result--that monopolist sellers may invest less in fixed costs (including plant modernization and research and development) than would the renters--is shown. It is also shown that, even though sellers have less monopoly power than renters and nondurable-goods monopolists, it is possible that the seller will cause a greater deadweight loss than the other types of monopolies.
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“Planned Obsolescence” is the production of goods with uneconomically short useful lives so that customers will have to make repeat purchases. However, rational customers will pay for only the present value of the future services of a product. Therefore, profit maximization seemingly implies producing any given flow of services as cheaply as possible, with production involving efficient useful lives. This paper shows why this analysis is incomplete and therefore incorrect. Monopolists are shown to desire uneconomically short useful lives for their goods. Oligopolists have the monopolist's incentive for short lives as well as a second incentive that may either increase or decrease their chosen durability. However, oligopolists can generally gain by colluding to reduce durability and increase rentals relative to sales. Some evidence is presented that appears to be generally consistent with the predictions of the theory.
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We consider a durable-good monopolist that periodically introduces new models, each new model representing an improvement upon its predecessor. We show that if the monopolist is able neither to exercise planned obsolescence (i.e., artificially shorten the lift of its products) nor to give discounts to repeat customers, the rate of product introductions is too slow -- in comparison with the social optimum. On the other hand, if the monopolist is able to artificially shorten the durability of its products or to offer price discounts to repeat customers, it can raise its profit and, at the same time, implement the social optimum.
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We study monopoly pricing of overlapping generations of a durable good. We consider two sorts of goods: those with an active secondhand market and anonymous consumers, such as textbooks, and those with no secondhand market and consumers who can prove that they purchased the old good to qualify for a discount on the new one, such as software. In the first case we show that the monopolist may choose to either produce or repurchase the old good once the new one becomes available. In the latter case we determine when the monopolist chooses to offer upgrade discounts.
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By investing in R&D, a durable-goods monopolist can improve the quality of what it will sell in the future, and in this way reduce the future value of current and past units of output. This article shows that if the firm sells its output, then it faces a time inconsistency problem; i.e., the R&D choice that maximizes current profitability does not maximize overall profitability. The result is that if output is sold rather than rented, then in its R&D decision the monopolist has an incentive to practice a type of planned obsolescence that lowers its own profitability.
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A monopoly producer of a durable good is examined under the (previously uninvoked) assumption that the good depreciates, and hence that replacement sales must occur if a fixed stock of the good is to be maintained. We find two ways in which the no-depreciation result, that the monopoly will always (at least eventually) produce a stock equal to that produced by a competitive market, may not hold. If the length of the trading period is nonzero, the limiting stock produced by the firm will be lower than the competitive stock, to ensure the profitability of future replacement sales. If the firm is able to constrain its production capacity, it may choose a constraint that always binds in the sense that it will be impossible for the firm to achieve a stock equal to the competitive stock.
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The market for a durable good sold by a monopolist is examined by using both continuous-time and discrete-time versions of the same model. The requirement that buyers' expectations must be fulfilled along the realized path of production is shown to place no restrictions on that path. Even the stronger requirement that buyers' expectations must continue to be fulfilled in the presence of any unexpected, exogenous perturbation to the stock places no restrictions, if expectations are allowed to depend discontinuously on the current stock. However, if expectations must depend continuously on the current stock, there is a unique equilibrium. This equilibrium is stationary, and the seller's strategy is the one described by Coase (1972): to keep the market saturated at all dates. Hence the path for output is the one for a competitive market and profit is zero. Stationary equilibria are then examined using the discrete-time model and it is shown that the path for output is very sensitive to the length of the period. As the period shrinks, the equilibrium approaches the one described above. But as the period grows, the path for output approaches the one chosen by a monopolist renter and profit approaches a maximum.
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A new generation of durable goods makes an old generation economically, even if not physically, obsolete. Economic obsolescence due to technological innovation requires the durable goods monopolist to implement price discrimination in two dimensions, both between consumers with different valuations and between consumers with different purchase histories. Equilibrium in the game between the durable goods monopolist and consumers depends on the extent of economic obsolescence and the relative sizes of the consumer groups. Underinvestment in innovation may take place. This contrasts with the standard literature on planned obsolescence where the durable goods monopolist overinvests in durability reducing technology. Copyright 1998 by Blackwell Publishing Ltd
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This paper attempts to provide a formal theory of planned obsolescence based on incompatible technologies in the presence of network externalities. The author explores how a monopolist's ability to make the new product incompatible with the old version of a product constrains the optimal dynamic behavior of the monopolist. The social optimum and the market equilibrium are compared. Finally, the possibility of quality distortion is considered as a commitment mechanism to the future compatibility choice. Copyright 1994 by Blackwell Publishing Ltd.
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This paper analyzes durable goods monopoly in an infinite-horizon, discrete-time game. The authors prove that, as the time interval between successive offers approaches zero, all seller payoffs between zero and static monopoly profits are supported by subgame perfect equilibria. This reverses a well-known conjecture of Coase. Alternatively, one can interpret the model as a sequential bargaining game with one-sided incomplete information in which an uninformed seller makes all the offers. The authors' folk theorem for seller payoffs equally applies to the set of sequential equilibria of this bargaining game. Copyright 1989 by The Econometric Society.
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Fudenberg, D. and J. Tirole, 1998, " Upgrades, Tradeins, and Buybacks, " Rand Journal of Economics, 29, 235–58.
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Gul, F., H. Sonnenschein, and R. Wilson, 1986, " Foundations of Dynamic Monopoly and the Coase Conjecture, " Journal of Economic Theory, 39, 155–190.
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Choi, J.P., 1994, " Network Externality, Compatibility Choice, and Planned Obsolescence, " Journal of Industrial Economics, 42, 167–182.