Innovation Is the New Competition: Product Portfolio Choices with Product Life Cycles

Peichun Wang, Business Economics and Public Policy, The Wharton School

Abstract: The product life cycle, or time path of sales, of many high-tech goods and services is bell-shaped. I show that product life cycles endogenously arise in markets with rapid technological innovations, are heterogeneous across products, and are affected by the level of market competition. Using product life cycles as an empirically tractable way to capture firms’ dynamic incentives in product introductions, I study the effect of competition on firms’ product portfolio choices and product entry and exit decisions in the context of the Chinese smartphone market. I develop a structural model of equilibrium product portfolio choices, and estimate smartphone demand and manufacturers’ variable, maintenance and sunk introduction costs on a detailed monthly market-level dataset of Chinese smartphones between 2009 and 2014. Finally, I use a 2012 large-scale pro-competitive policy introduced by the Chinese government as an experiment to decompose the handset manufacturers’ incentives to introduce new products and show that the increased competition reduces the average product’s short-run profits by 5% but its lifetime profits by 41% by shrinking its product life cycle. These dynamic incentives have large implications for both consumer welfare gains from product variety and the speed of product innovation in this market.

Read the full working paper here.

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