Industry equilibrium with sustaining and disruptive technology

Abstract

This paper considers a special type of technology evolution, referred to in the literature as disruptive technology vs. sustaining technology. In general, "old" products based on sustaining technology are perceived to be superior to the "new" ones based on disruptive technology. However, the latter have distinctive features that allow them to attract an exclusive set of customers. Examples include notebooks vs. netbooks, hard-disk drives vs. solid-state drives, laser printers vs. inkjet printers, etc. We set up a model with an established firm and an entrant firm that have heterogeneous product-offering capabilities: the established firm can offer either or both types of products, while the entrant firm can only offer the new products. Firms make capacity, pricing, and quantity decisions that maximize their ex-ante profit. Within this framework, we analyze deterministic games with perfect information and stochastic games with uncertain valuation of the disruptive technology. Equilibriums decisions are discussed under various market conditions as well as dedicated vs. flexible capacity assumptions. While over-investment and over-production may occur in a stochastic game with dedicated capacities, the equilibrium capacity decision seems to be more rational if the establish firm utilizes flexibly capacity or if the dedicated capacity can be converted ex-post at some expense.