DP4089 Credible Vertical Preemption
This study shows that preemptive investment in product proliferation is subject to a commitment problem that is not constrained to models of horizontal product differentiation, but applies to vertical product differentiation settings as well. We investigate the incentives of firms producing high- or low-quality goods that decide simultaneously to introduce new products in different quality areas. In addition, we analyse whether these firms keep or withdraw similar existing products from the market. The study shows that the introduction of new products depends on the credibility of firms' innovation strategies. The high-quality firm's strategy to proliferate the product space in order to deter the low-quality firm from introducing a new product is not credible. Innovators always withdraw their existing products from the market in order to reduce price competition or to avoid cannibalizing demand for their own products.