Can Strategic Customer Behavior Speed Up Product Innovation?

Abstract

We study a monopolistic firm which introduces two product versions sequentially in two periods. We analyze and compare the firm's decisions on the innovation level of the new version, the production quantities and prices of both versions, and the associated profit in four settings: when the customers are myopic or strategic in period 1 and whether the leftover inventory of the old version is phased out from the market (single rollover strategy) or is sold in the market (dual rollover strategy). In period 2, newcomers who wish to buy the new version arrive in the market. We show that the firm can improve both its profit and its innovation level by adopting an appropriate rollover strategy when selling to strategic customers. This finding underscores the importance of choosing a rollover strategy. Interestingly and differently from the existing literature, we see that strategic waiting behavior can accelerate innovation. These analytical insights remain largely valid when some of the customers who cannot get the old version due to a stockout leave the market before the new version arrives, or when some of the newcomers are interested in the new version as well as the leftover old version.