The Dynamic Effect of Innovation on Market Structure

Abstract

Product innovation is endemic among consumer packaged goods firms and is an integral component of their marketing strategy. As innovations affect markets, there is a pressing need to develop market response models that can adapt to such changes. The authors' model copes with the challenges that dynamic environments entail: nonstationarity, changes in parameters over time, missing data, and cross-sectional heterogeneity. They use this approach to model sales response in the frozen pizza category, in which the introduction of rising-crust pizza brands represents a major innovation. The model is directly applicable to other domains in which market structure might be nonstationary, such as changes in promotion strategy, shifts in the retail environment, and movements in macroeconomic factors. The authors find that innovation (1) makes the existing brands appear more similar, as indicated by increasing cross-brand price elasticities; (2) decreases brand differentiation for the existing brands, as indicated by an increase in the magnitude of own-brand price elasticities; and (3) increases the variance of the sales response equations temporarily around the time of the introduction of the innovation, indicating increased uncertainty in sales response. The authors discuss the managerial implications by presenting maps of how clout and vulnerability evolve over time, assessing the effect of new brands on cannibalization, and considering the strategic implications of the introduction of a flanker innovation to facilitate an extant brand's ability to attack an incumbent leader.