Product and Price Competition with Selection of Unique and Common Features and Different Quality Levels

We consider two competing firms' new product introduction and pricing problem where both firms introduce their products sequentially and set their prices at equilibrium. We use discrete features with different quality levels. Products can have unique features that are present only in one product, and common features that are shared between two products. A case where the competitor competes only on price with an existing product is also considered. The firms' new product introduction problem is formulated as a mixed-integer nonlinear program and the firms' pricing problem is formulated as a nonlinear program. The optimal feature selection and the resulting equilibrium prices are derived in analytically. For linear product value, demand, and cost functions, we analytically determine the conditions for which it is optimal to include features in the firms' product and how to select their quality levels optimally in anticipation of the features and the quality levels of the competitor's product. The optimal selection of unique features depends only on the value and cost of that feature's quality levels and the firm's own-price sensitivity. In addition, the optimal selection of common features also depends on the firms' cross-price sensitivities and the value but not on the cost of the competitor's quality levels of that feature. If the competing firms are symmetric, the first firm to introduce a product obtains a higher profit even with some lower quality feature levels compared to the second firm. When the first firm has a competitive advantage, e.g. having less own-price sensitivity than its competitor, and the second firm can respond only with price, the first firm prefers high-quality feature levels in its products. If it does not have this advantage, it differentiates its product via feature selection to lessen substitution effects