Introduction Sequence with Functionality Threshold and Real Option

Abstract

Existing literature on introduction sequence mostly argues against introducing a low-end product before a high-end product. In this paper, we present a simple model to show when it can be optimal to introduce a low-end product first. Based on some observations in industry, high-end consumers are not only wealthier, but also more demanding in quality. With this property, introducing a low-end product first without commitment would not cannibalize the high-end segment because it does not satisfy the quality requirements of the high-end consumers. We also allow for a stochastic environment: the firm may find it valuable to retain flexibility, or the so-called “real options”, rather than make commitment about forthcoming products. With this model setup, we add a different perspective that it can be optimal to introduce a low-quality product first for purely marketing reasons. We show that functionality thresholds can play the same role as Piguovian third degree discrimination.