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Mass Customization with Vertically Differentiated Products

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We analyze a duopoly game in which products are initially differentiated in variety and quality. Each consumer has a most preferred variety and a quality valuation. Customization provides ideal varieties but has no effect on product qualities. The firms first choose whether to customize their products, then engage in price competition. We show that in equilibrium either both firms customize, only the higher quality firm customizes, or no firm customizes. Even if customization is costless, the firms might not customize. This happens when the quality difference between the firms is small. We explore how the total welfare changes with the fixed cost of customization. Interestingly, the relationship is not always monotonic. Contrasting with the situation when customization is not feasible, both consumer surplus and total welfare are higher when one or both firms customize.

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File URL: http://www.netinst.org/Loginova_Wang_08-33.pdf
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Bibliographic Info

Paper provided by NET Institute in its series Working Papers with number 08-33.

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Length: 26 pages
Date of creation: Sep 2008
Date of revision:
Handle: RePEc:net:wpaper:0833

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Web page: http://www.NETinst.org/

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Keywords: customization; horizontal differentiation; vertical differentiation;

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  1. MacCarthy, Bart & Brabazon, Philip G. & Bramham, Johanna, 2003. "Fundamental modes of operation for mass customization," International Journal of Production Economics, Elsevier, vol. 85(3), pages 289-304, September.
  2. Selladurai, R. S., 2004. "Mass customization in operations management: oxymoron or reality?," Omega, Elsevier, vol. 32(4), pages 295-300, August.
  3. Alexei Alexandrov, 2006. "Fat Products," Discussion Papers 1435, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Bernhardt, Dan & Liu, Qihong & Serfes, Konstantinos, 2007. "Product customization," European Economic Review, Elsevier, vol. 51(6), pages 1396-1422, August.
  5. Nan Xia & S. Rajagopalan, 2009. "Standard vs. Custom Products: Variety, Lead Time, and Price Competition," Marketing Science, INFORMS, vol. 28(5), pages 887-900, 09-10.
  6. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  7. Neven, D. & Thisse, J-F., 1989. "On Quality And Variety Competition," CORE Discussion Papers 1989020, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  8. Niladri B. Syam & Ranran Ruan & James D. Hess, 2005. "Customized Products: A Competitive Analysis," Marketing Science, INFORMS, vol. 24(4), pages 569-584, February.
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