Managing Reference-Group Effects in Sequential Product Upgrades

In this paper, we examine how firms can leverage reference-group effects (RGEs) in sequential introduction of upgraded products. RGEs arise when consumers engage in social comparisons: leaders desire to distinguish themselves from followers and followers desire to mimic leaders. We find that RGEs have a non-monotonic impact on the profitability of product upgrades: a stronger RGE first increases and then decreases profits. This inverted-U effect is fundamentally driven by two opposite effects of RGEs: a positive push effect on leaders’ upgrading to a new generation when followers adopt an existing product that leaders possess, and a negative pull effect on followers’ adoption of the existing product when leaders upgrade to the new product. We also offer insights on inter-generational differentiation in the presence of RGEs. We find that by coordinating product differentiation in two dimensions, functional improvement and exterior form, the firm is able to eliminate the negative pull effect, which occurs when the strength of RGEs is intermediate. In such cases, both functional improvement and exterior differentiation increase with the strength of RGEs. When the strength of RGEs is sufficiently high, however, the firm will focus on exterior differentiation rather than functional improvement. Managerial implications are discussed