Managing product upgrades and rollover under demand uncertainty

Abstract

We study the optimal product upgrades and rollover strategies of a risk-averse firm that is uncertain about future demand. For this purpose, we develop a two-period model based on whether the firm makes upgrading investments and if so which product rollover (solo or dual) strategy it adopts. Analysis of the equilibrium outcomes shows that if the firm is moderately risk-averse, it is unprofitable to upgrade and therefore only sells the first-generation product over two periods. Otherwise, the firm benefits from upgrading investments. In this case, the (solo-) dual-rollover guarantees the maximum total payoff if the degree of risk aversion is (low) high. Our sensitivity analysis demonstrates that: (i) the dual-rollover strategy can be seen as a hedge against increased demand uncertainty; (ii) the firm has a higher likelihood of using the dual-rollover strategy as cannibalization intensifies or intertemporal demand spillovers increase; and (iii) a lower payoff discount rate generally discourages the firm from upgrading the product. When upgrading investments happen, the optimal product rollover strategy is contingent upon the degree of risk aversion and the payoff discount rate.