Time for upgrades? In time for consumers and competition

Abstract

An upward line extension is a new, improved product within an existing product category for the high-end market. Many manufacturers pursue line-extension strategies, but they carry risks due to uncertain consumer taste, the internal competition between products, and the external competition between firms. We use game theory to answer when a firm should allocate production capacity for an upward line extension under competition and consumer taste uncertainty. The firm can either act early when taste is still uncertain to benefit from the first-mover advantage or wait until consumer taste realizes. We measure consumer taste risk by the correlation between the average consumer taste and the density of consumer taste, with a strong correlation meaning a considerable risk exposure, foreshadowing a more likely hit-or-miss result for the new product. The firm’s competitive advantage is based on both firms’ expected marginal revenues of capacity allocation, considering the internal and external competition. We show how the competitive advantage will amplify exponentially in the face of consumer taste uncertainty and characterize the firm’s decision policy by deriving a threshold for the risk index against the competitive advantage index. When the threshold is exceeded, it implies that the firm’s competitive advantage is not significant enough, so it should postpone allocating capacity. Otherwise, it should act early. We apply our results to two industry examples and provide practical guidelines to manufacturers for determining the right capacity timing for an upward line extension.