The Introduction of New Product Qualities by Incumbent Firms: Market Proliferation versus Cannibalization

Abstract:     
This study analyzes the optimal provision of goods in a market characterized by vertical product differentiation. We consider a duopoly model in which incumbents may introduce a new product with certain quality, and decide whether to keep or to withdraw the existing product from the market. We find that the strategic and cannibalization effects dominate, such that no room is left for discrimination among consumers. The innovator always withdraws the existing product from the market, in order to reduce price competition and to avoid cannibalizing its new product demand. In contrast to horizontally differentiated markets, firms are better off not to offer a range or interval of product qualities in vertically differentiated markets. Hence, firms fare better, despite offering a smaller variety of goods.

Number of Pages in PDF File: 26

Keywords: Asymmetric firms, cannibalization, market proliferation, new product introduction, product innovation, vertical product differentiation

JEL Classification: L11, L13, O31, O32

working papers series