Tethered Durable Goods and Installed Base Degradation via Software Updates

Abstract

In this paper we study a monopolist technology vendor's decision to degrade their installed base when they release their newer version. An installed base of products that are technologically tethered, whether digital products such as smartphones or predominantly non-digital products such as automobiles, can be degraded in performance through software updates. This raises new possibilities and temptations for sellers, and therefore new questions not hitherto addressed in the literature on durable goods and innovation, on the optimal product policy for durable goods monopolists. In contrast to the traditional planned obsolescence literature, where the seller has to introduce novel versions (novel in either fashion or functional features) to obsolete their installed base of older versions, in the changed scenario when a seller can degrade their installed base via a software update, they don't have to rely on product novelty to encourage consumers to buy the new product. In a two-period setting featuring a monopolist selling a durable good to a unit mass of consumers with uniformly distributed valuation for the good, we show that installed base degradation can emerge in equilibrium, with or without innovation. In the absence of innovation (i.e. same durable good available for sale in both periods), our model first finds that the seller is mostly better off not degrading their installed base in period 2, except for products with very low marginal cost relative to value, which should be leased and not sold. Nevertheless, the seller faces a commitment problem and is tempted to degrade the installed base in period 2, for a substantial part of the parameter space. Next, in the presence of innovation, we find that the seller is better off not degrading the earlier version in the later period, when the marginal cost is high relative to product value, and innovation is low, or when marginal cost is very low and innovation is very high. But there exists a substantial region in the middle, when marginal cost is low to medium, and innovation is medium to high, when the seller earns a higher profit overall by degrading their installed base in period 2, which explains why durable goods vendors may face incentives to engage in this practice. With innovation, there also exists a region in the parameter space where the seller faces a commitment problem and achieves sub-optimal profit by degrading their installed base in period 2, when they could earn a higher profit by refraining from doing so. Even when the seller degrades the installed base, they choose a sub-optimal price, due to a different kind of commitment problem. In the no-innovation scenario, installed base degradation is mostly sub-optimal to the seller due to the commitment problem, whereas in the innovation scenario, installed base degradation is mostly optimal with a relatively smaller sub-optimal region.