Competing with co-created products

The practice of upstream firms (suppliers) and downstream firms co-creating products (goods or services) together has a long history in business markets. We analyze the strategic choices of two competing downstream firms who simultaneously decide whether or not to co-create with an upstream supplier. Within this framework we incorporate endogenous pricing and effort choices by the upstream supplier and the downstream firms. Downstream firms contemplating co-creation with a supplier are faced with a trade-off. On the one hand they can benefit from the supplier's innovation efforts and therefore obtain a better product. On the other hand, they are confronted with the adverse effect of their own innovation efforts spilling over to their rivals via the supplier who would sell the co-created product to all firms. Our model captures this tension and offers several insights. First, we show that all the channel members (the supplier and the firms) are getting higher profits when they all co-create together, as compared to the situation where there is no co creation and the Supplier alone designs the product. However, we also demonstrate that the abovementioned trade-offs provide an incentive for firms to deviate from this outcome, sometimes resulting in no-co-creation between the downstream firms and upstream supplier in equilibrium. Further, we show that in the competitive co-creation environment, ex-ante symmetric firms may pursue asymmetric strategies in equilibrium. The asymmetric equilibrium, in which only one of the two firms co-creates with the supplier, is obtained when the degree of price sensitivity to competitor's product in the consumer market is moderate. Third, we find two types of asymmetric equilibria. For moderately low degrees of price sensitivity, all parties prefer the asymmetric outcome. For moderately high price sensitivity, both firms prefer co-creation, but the supplier will refuse to co-create with one of them thereby enforcing the asymmetric outcome. Thus, a strategic supplier's role is critical in that it expands the region where the asymmetric equilibrium takes place, beyond the one preferred by the firms themselves. We also show that, when firms compete in the end-consumer market, the supplier may exert lower innovation effort when it co-creates with two firms as compared to one. This is not the case in the absence of competition between the downstream firms. Finally, and counterintuitively, a higher degree of product fit for the rival can actually benefit the co-creating firm in the asymmetric outcome, even though it improves its rival's product. (C) 2018 Elsevier B.V. All rights reserved.