The impact of technology on product design, productivity, and profits: a duopoly model of price-quality competition

Abstract

This paper develops a two stage economic model of duopoly competition to examine the impact of technology investments in product design tools on product quality and price, firm productivity and profits, and consumer welfare. In the first stage the firms simultaneously choose product quality and in the second stage, after observing each other's quality choices, the firms simultaneously set prices. This model captures the firm's option to leverage technology tools to improve product quality and tracks the effect of such quality adjustments on measures of firm performance and consumer welfare. More specifically, the findings show that profit-maximizing firms leverage technology-based design tools to improve product quality, resulting in higher levels of firm profits and consumer welfare; however, these improvements come at the expense of productivity. Alternatively, the findings show that firms that fail to improve quality, and instead leverage the tools to reduce production costs, realize higher levels of productivity; however, this improvement in productivity comes at the expense of profits and consumer welfare. The results of the analytical model cast a new light on why it may be reasonable to empirically observe reductions in firm productivity following investments in IT tools that improve production capabilities.