Innovative development strategy of a risk-averse firm considering product unreliability under competition

Abstract

This paper aims to seek the innovative development strategy for a leading firm in a competitive market when considering product unreliability and risk behavior. A higher innovation level may bring about better product performance. Nevertheless, it may cause some unreliability events which might incur serious negative outcomes (e.g., products recall). Facing uncertain outcomes, the innovative firm may care more about the risk of innovation when making decisions, especially in a competitive market. We build a Stackelberg game model for a competitive market consisting of a leading firm and a competitor. The Conditional Value-at-Risk (CVaR) is used to measure the firm’s risk attitude. The optimal innovation strategy of the leading firm and the response strategy of the competitor is obtained. We find that the optimal innovation strategy takes three different forms depending on the risk attitude and the development cost of innovation. i.e., no innovation, complete innovation and partial innovation. In addition, different from most existing literature on risk-averse players’ pricing decisions, we find that a risk-averse innovative firm may set a higher price to focus on only tech-savvy consumers. Moreover, the effects of innovation are also investigated. We find that the two competing firms can achieve a win–win result by adopting an appropriate innovation strategy.