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Strategic Value of Price Differentiation for Customized Products

Author

Listed:
  • Dinah A. Cohen-Vernik

    (University of Houston-Downtown)

  • Amit Pazgal

    (Rice University)

  • Xuyeing Liu

    (Nankai University)

Abstract

The continued development of product customization technologies has enabled firms to better satisfy the individual tastes of their customers. Nearly all consumers today expect some level of customization in the products they purchase, and brands selling anything from dress shirts to packaged goods have embraced the strategy of tailoring products to customer preferences. In today’s competitive landscape, firms face two fundamental customization decisions: (1) strategy (whether to offer customized products) and (2) scope (to what extent products should be customizable). We construct a game-theoretic model of duopolistic competition, integrating elements from the existing literature on customization in a unique way to analyse the impact these elements have on the outcomes of customization-related decisions. The model is solved to derive equilibrium outcomes in customization strategy, the extent of customization, pricing, demand, and profits. These outcomes are discussed and compared across two scenarios: firms employing a uniform versus differentiated pricing policy, with a focus on demonstrating the strategic value of price differentiation beyond merely extracting consumer surplus. The analysis provides several insights into the challenges and opportunities firms face when offering customizable products. For example, we find that when both firms pursue a customization strategy, it often leads to a prisoner's dilemma, suggesting that widespread customization may not be profitable. Comparing equilibrium strategies under uniform and differentiated pricing reveals potential inefficiencies of the former and strategic benefits of the latter, such as reducing the prisoner’s dilemma cost or, under certain conditions, preventing the prisoner’s dilemma outcome altogether. Further, the profit benefits of treating the choice of strategy and scope as two distinct decisions are discussed, highlighting the value of price differentiation in making these benefits more salient.

Suggested Citation

  • Dinah A. Cohen-Vernik & Amit Pazgal & Xuyeing Liu, 2025. "Strategic Value of Price Differentiation for Customized Products," Customer Needs and Solutions, Springer;Institute for Sustainable Innovation and Growth (iSIG), vol. 12(1), pages 1-19, December.
    • Handle: RePEc:spr:custns:v:12:y:2025:i:1:d:10.1007_s40547-024-00148-z
    DOI: 10.1007/s40547-024-00148-z
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