Competing through mass customization

Abstract

We consider a market with heterogeneous customer tastes served by a duopoly. In our base model the firms first decide whether to adopt MC, which enables a firm to provide each customer her ideal product configuration. A firm that chooses not to invest in MC serves a standard product. Following investment decisions, the firms competitively price their products. A customer evaluates a product alternative considering its price and misfit relative to her ideal point (and delay in our extended model). We solve for the resulting equilibrium and study its characteristics. We then study the competition between a firm that adopted MC and a firm that continues to sell standard products in more detail extending our base model to account for some key operational differences between these two firms: While the firm selling standard products usually carries product inventories, the firm selling custom products does not carry inventory, it makes-to-order and its customers incur waiting costs until they receive their orders. Our results are useful for characterizing conditions that favor custom and standard products under competition. We find that the value of mass customization critically depends on the firm’s competitive position, determined by its cost efficiency and perceived quality vis-à-vis its competitor: It may not be desirable even at zero cost due to its negative effect on price competition. A firm with an overall cost and quality disadvantage never adopts mass customization. We show that allowing firms to set custom prices for each product configuration leads to a broader adoption of mass customization compared to when they are restricted to uniform prices. Furthermore, we find that a customizing firm’s profit is not monotone in the market size and its ease of customization when competing against a firm selling standard products. We show that its competitive position crucially affects its ideal market size and its returns from improving the ease of customization.