Capacity Deployment for Next-Generation Products in a Competitive Market

An upward line extension is a new improved product in the same product category for the high end of the market. Most firms are pursuing line-extension strategies, however, such strategies carry risk due to uncertain consumer taste, the internal competition between products, and the external competition between firms. “Bad timing” is often mentioned as one of the main reasons for new product failures. Using game-theoretic models, we study when a firm should deploy production capacity for an upward line extension in a competitive market. A firm can either deploy capacity early when consumer taste is still uncertain to benefit from a first-mover advantage or wait until consumer taste is realized. We develop two indexes to evaluate consumer taste risk and a firm's competitive advantage, respectively. Consumer taste risk can be measured by the correlation between the average consumer taste and the density of consumer taste: a strong correlation implies a large exposure to risk, indicating more likely a hit-or-miss result for the new product. A firm's competitive advantage is evaluated based on both firms' expected marginal revenues of capacity expansion, each of which considers a firm's capacity cost advantage over the competitor and the competitor's gain from offering the same quality upgrade. We show how a firm's large competitive advantage will be magnified in the evaluation under the impact of consumer taste uncertainty, and characterize the decision policy for a firm as a threshold for the consumer taste risk index with respect to the competitive advantage index. Exceeding this threshold, a firm's competitive advantage is insufficiently large so that it should postpone capacity deployment. Otherwise, it should act early. We apply our results to two industry examples and provide practical guidelines.