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Wilfrid Laurier University School of Business & Economics
October 20, 2014
Canadian Excellence

Dr. Yuanfang Lin

Date: Friday Nov. 22, 2013
Time: 1:30 - 3pm
Ernst & Young Boardroom
Dr. Yuanfang Lin
Topics: The Blessing of Targeted Innovations in a Competitive Market

Yuanfang Lin (Laurier)
Amit Pazgal (Rice)
David Soberman (Toronto)

Technical product innovation is a key component of competitive strategy but a firm must develop as well as introduce new technology to gain advantage. In fact, rapid advances in technology and product evolution may result in some innovations not being fully understood by consumers. This makes choosing the optimal level of product innovation a challenging task for firms in competitive markets. To examine this question, we study a firm's decision in terms of both the nature of innovation and pricing strategy when it enters a market with an incumbent that provides a basic product with technology that everyone understands. In a stylized market with two consumers, an entrant chooses between introducing a new product that represents a) a drastic innovation for one consumer or b) a general improvement of smaller magnitude that both consumers value. Drastic innovation generally entails new or advanced functions that the basic product does not provide but these new features may not be appreciated by all consumers. This implies that the willingness to pay for an innovation classified as drastic is often heterogeneous. Our analysis shows that, when an entrant introduces a drastically innovative product that is perceived heterogeneously, price competition with the incumbent leads to mixed-strategy equilibrium where the entrant maximizes profit from the consumer that is willing to pay extra for the new features. In contrast, an entrant with a new product classified as a general improvement sets price to capture business from both consumers. Under these conditions, sales for the incumbent's product often tail off quickly. The ability to substantially reduce the incumbent sales suggests that general improvements should be globally preferred to drastic innovations that appeal to a sub-segment. This reasoning is however, flawed. To understand why, the model highlights the indirect effects of product introduction on market competition. In particular, to create equivalent profit for an entrant, a general improvement needs to create significantly more value in the market than a product associated with a drastic innovation for a sub-segment. The reason is that a targeted drastic innovation relaxes price competition with the incumbent. This finding has important managerial implications for firms that use new product development and pricing to compete for consumers who are heterogeneous in their acceptance of new technology.

Keywords: innovation, targeting, mixed pricing strategies, drastic innovations.