Strategic Investment Timing and Consumer Savviness for Add-On Services

We examine duopolistic competition within a real options framework, where two firms provide horizontally differentiated core goods along with vertically differentiated add-on services. Focusing on consumer savviness regarding the quality of add-on services, we analyze its impact on prices, investment timing, and social welfare. Our analysis yields three main findings. First, the price of a core good with high-quality add-on services is lower (resp. higher) than that of a core good with low-quality add-on services when the proportion of non-savvy consumers in the population is high (resp. low). Second, both firms are incentivized to invest preemptively when the proportion of non-savvy consumers is high or the quality difference in add-on services is small; however, when the proportion of non-savvy consumers is low or the quality gap is significant, only the firm offering high-quality add-on services retains this incentive. Third, as the proportion of non-savvy consumers decreases, the flow of social surplus increases; nonetheless, the overall expected social welfare may decline due to a delay in the follower's investment and a prolonged monopoly duration. This suggests a need for a policy mix that combines consumer protection with the encouragement of market entry.