Capacity Deployment for Next-Generation Products in a Competitive Market

Improving on existing products is an effective product differentiation strategy for firms. We refer to such improved products as next-generation products (NGPs). Research shows that 40% of product transitions fail and that some lead to bankruptcies. Bad timing is often mentioned as one of the main reasons for NGP failures. Using game-theoretic models, we study when a firm should deploy production capacity for an NGP in a competitive market. A firm can either deploy capacity early when consumer taste is still uncertain so that it may benefit from a first-mover advantage, or decide to wait until the demand is realized. We find that a firm's NGP capacity deployment strategy should consider the trade-off between demand risk and competitive advantage. Demand risk in the market can be measured by the correlation between the average consumer taste and the density of consumer taste: a strong correlation indicates a large exposure to demand risk. A firm's competitive advantage in the transition to an NGP is based on the expected marginal revenues of capacity expansion of both firms, considering the capacity cost advantage over the competitor and the competitor's gain from offering the same quality upgrade. By evaluating both a firm's competitive advantage and its exposure to demand risk in the market, we identify risky situations for the firm and derive the optimal strategy in each scenario: in a risky situation, the firm should postpone capacity deployment for an NGP; otherwise, it should act early. We apply our results to two NGP examples and provide practical guidelines on how firms can identify their respective competitive situations in the transition to an NGP and what the best capacity deployment timing is based on these situations