Mass Customization with Vertically Differentiated Products

We analyze a duopoly game in which products are initially differentiatedin variety and quality. Each consumer has a most preferred variety and aquality valuation. Customization provides ideal varieties but has noeffect on product qualities. The firms first choose whether to customizetheir products, then engage in price competition. We show that inequilibrium either both firms customize, only the higher quality firmcustomizes, or no firm customizes. Even if customization is costless,the firms might not customize. This happens when the quality differencebetween the firms is small. We explore how the total welfare changeswith the fixed cost of customization. Interestingly, the relationship isnot always monotonic. Contrasting with the situation when customizationis not feasible, both consumer surplus and total welfare are higher whenone or both firms customize.