Sequential Innovation and Market Structure

This paper concerns the introduction of a sequence of new, higher-quality durable products in a market in which there already exists a lower-quality substitute. The product has the further attribute that a real resource cost is incurred at the time a higher-quality product is first used. This stylized feature of our model represents several common characteristics of commodities in evolving markets. Computers and electronic consumer durables are evident examples.
The two key features of this commodity, its exogenously improving quality and the cost incurred in first-time use, interact in interesting ways. We study the cases of a monopoly who can control the product price over time, and a sequential oligopoly in which the currently-best variety of the good is produced by only one firm, but each improvement is owned by a new potential entrant.
In the monopoly case there is a tendency for the monopolist to suppress the earlier technologically inferior varieties of the product, waiting for the better ones that will be available later, even when it would be socially optimal for the consumers to switch to the earlier innovation and switch again to the subsequent variety. The reason for this is that the monopolist can sell the subsequent innovation for a higher price if consumers do not own the earlier innovation.
In the sequential duopoly case a different phenomenon is operative. There is a tendency for the earlier innovation to be produced and sold, at a profit, when it should be suppressed in favor of waiting for the superior quality good. This is because consumers correctly believe that if they do not buy early, the subsequent innovation's producer will charge them a monopoly price and they will get no surplus.