Selling Smart and Connected Products: A Value Chain Perspective

Abstract

The rise of smart and connected products has led to unprecedented data richness and the ever-increasing product connectivity, which catalyze the emergence of the data network effect and present a fresh opportunity for product innovation. This paper investigates whether and how connected product providers can leverage the data network effect through the optimal interplay of selling and innovation strategies. In the model, in a two-tier value chain, a manufacturer and a retailer sequentially choose their respective strategies to sell a smart product that exhibits data network effect. In the short-run analysis where the product connectivity is fixed, we show that, surprisingly, the value chain can achieve efficient strategic coordination under a conventional wholesale-price contract when the product connectivity is relatively high. In the long-run analysis where the manufacturer can engineer the strength of network effect through data analytics, the decentralized value chain may achieve greater social welfare than the integrated one, because the manufacturer with a high innovation capability would invest more aggressively in the product connectivity to mitigate the retailer's pricing externality. This implies that the classic double marginalization problem has an unexpected beneficial effect by enhancing productive investments for smart and connected products.

Keywords: Smart and Connected Product, Value Chain, Pricing, Engineering Network Effects, Connectivity

JEL Classification: L10