The effect of secondhand markets on the firm's dynamic pricing and new product introduction strategies

Abstract

This paper examines the effect of secondhand markets for durable goods on the firm's dynamic pricing and new product introduction strategies. Our model differs from previous new product studies because we simultaneously consider several factors: secondhand markets, industry-specific differences (i.e., general cost conditions), different pricing strategies (uniform pricing and price discrimination), and demand externalities. In addition, the model allows nonbuyers from the past to remain in the market in the future. The main managerial results are twofold. Contrary to intuition, for well-defined scenarios, secondhand markets can actually increase the firm's profitability. In addition, secondhand markets will have differential effects on pricing across industries depending on the magnitude of the innovation (major, moderate, or minor) and whether demand externalities are present. For industries in which innovations are typically minor or moderate, the firm should not use a price discrimination strategy. For industries where innovations are major, the firm should not introduce the first-generation product; instead, the optimal strategy is to leapfrog and directly introduce the second-generation product in the future. Interestingly, for industries in which demand externalities are sufficiently strong (e.g., software), the secondhand market disappears. The effect of the secondhand market on product-line pricing is as follows. In the second period, new customers pay a lower price for the second-generation product. However, upgraders pay a higher price when secondhand markets exist. In the first period, the effect of secondhand markets on the price of the first-generation product is conditional and depends on whether the innovation is major, moderate, or minor. The effect of market growth on prices is unambiguous: all prices, including the secondhand and upgrade prices, increase (decrease) when the market is growing (declining).