Entry and Innovation in Vertically Differentiated Markets
This paper analyzes the optimal entry into experience goods markets with vertically diﬀerentiated buyers. We consider the case where the value of the new product is imperfectly known, but common to all buyers (common values) as well as the case where the quality is diﬀerent across buyers (private values). We distinguish between new products that are improvements to existing products and new products that are substitutes. Diﬀerent types of products have qualitatively distinct diﬀusion paths. Improvements are introduced slowly relative to the full information case, while substitutes are introduced more aggressively. The slow entry strategy is associated with increasing supply and decreasing prices over time. The reverse pattern holds for an aggressive entry strategy The incentives to innovate display a similar distinction. A ﬁrm with a currently inferior product opts for a large but risky innovation, whereas a currently superior producer chooses a smaller but certain innovation.
Bergemann, Dirk and Välimäki, Juuso, "Entry and Innovation in Vertically Differentiated Markets" (1999). Cowles Foundation Discussion Papers. 1474.