Competitive Customization

Abstract

We consider a duopoly market with heterogeneous customer tastes. The firms play a two-stage game. First, each firm chooses whether to invest in mass customization, which would enable it to offer customized products that increasingly match each customer's ideal product as the chosen customization level increases. A firm that chooses not to invest in mass customization serves a standard product. Second, the firms competitively price their product lines. We characterize each firm's investment in mass customization and study its dependence on competitive position, as determined by its cost efficiency and perceived quality vis-à-vis its competitor. We find that the value of mass customization critically depends on the firm's competitive position. It may not be desirable even at zero cost due to its negative effect on price competition. A firm with an overall cost and quality disadvantage never unilaterally adopts mass customization. We show that allowing firms to set different prices for each product configuration leads to a broader adoption of mass customization compared to when they are restricted to uniform prices. However, a firm's chosen customization level may be higher with uniform prices. Our analysis also helps a customizing firm determine whether to target its process improvement efforts for a lower cost or a higher customization level.