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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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Bibliographic Info

Paper provided by Department of Economics, University of Missouri in its series Working Papers with number 0814.

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Length: 20
Date of creation: 02 Jul 2010
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Handle: RePEc:umc:wpaper:0814

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Keywords: customization; horizontal differentiation; vertical differentiation;

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  1. Selladurai, R. S., 2004. "Mass customization in operations management: oxymoron or reality?," Omega, Elsevier, vol. 32(4), pages 295-300, August.
  2. 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).
  3. 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.
  4. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  5. Bernhardt, Dan & Liu, Qihong & Serfes, Konstantinos, 2007. "Product customization," European Economic Review, Elsevier, vol. 51(6), pages 1396-1422, August.
  6. Niladri B. Syam & Ranran Ruan & James D. Hess, 2005. "Customized Products: A Competitive Analysis," Marketing Science, INFORMS, vol. 24(4), pages 569-584, February.
  7. Alexei Alexandrov, 2008. "Fat Products," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 17(1), pages 67-95, 03.
    • Alexei Alexandrov, 2006. "Fat Products," Discussion Papers 1435, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  8. 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.
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