A Competitive Model of Customization with Lead‐Time Effects

Abstract

ABSTRACT In this article, we study the competitive interactions between a firm producing standard products and a firm producing custom products. Consumers with heterogeneous preferences choose between n standard products, which may not meet their preferences exactly but are available immediately, and a custom product, available only after a certain lead time l. Standard products incur a variety cost that increases with n and custom products incur a lead time cost that is decreasing in the lead time l. We consider a two‐stage game wherein at stage 1, the standard product firm chooses the variety and the custom firm chooses the lead time and then both firms set prices simultaneously. We characterize the subgame‐perfect Nash equilibrium of the game. We find that both firms can coexist in equilibrium, either sharing the market as local monopolists or in a price‐competitive mode. The standard product firm may offer significant or minimal variety depending on the equilibrium outcome. We provide several interesting insights on the variety, lead time, and prices of the products offered and on the impact of problem parameters on the equilibrium outcomes. For instance, we show that the profit margin and price of the custom product are likely to be higher than that of standard products in equilibrium under certain conditions. Also, custom firms are more likely to survive and succeed in product markets with larger potential market sizes. Another interesting insight is that increased consumer sensitivity to product fit may result in lower lead time for the custom product.

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