Competitive Product Versioning in the Presence of a Network Externality

Abstract

The existence of firms that offer multiple versions of the same product represent a curious occurrence. These firms not only compete against other firms in the market but the use of multiple product versions by the same firm implies that the firms compete against themselves as well. Sales cannibalization, in which a low cost version detracts sales from a higher cost version, is well documented in monopoly markets but remains mostly unaddressed in competitive markets. In order to study the issue of product versioning in competitive markets, this paper develops a model of catalog competition in which firms compete within a single market by offering multiple versions of the same product. The presence of a network externality is employed to motivate the use of multiple versions. It can be shown that under some basic assumptions, the set of stable catalog profiles of product versions is nonempty when acting firms endogenously select both prices and the characteristics of multiple product versions. Using a simulation, properties of these stable profiles are demonstrated in a stylized version of the model. The results of these simulations suggest that these markets feature high price competition, considerable cannibalization effects, and rarely sustain multiple firms. Furthermore, firms are found to only offer free versions of products when the value of the externality is neither too high nor too low.