Came across a really interesting paper the other day by Matthew Osbourne of the U.S. D.O.J., Antitrust. I'll be working through it over the next couple days.
When it comes to introducing new products, there are lots of things going on that are easily confused. For starters, suppose that the new product is introduced with a low price, with the idea that the introductory price increases later. If we observe someone trying the product and then abandoning it, are we seeing a person who is very price sensitive, or are we seeing someone who learned that he didn't like the product? If you aren't careful, these two behaviors will look the same.
Another thing to consider is the counter-intuition behind a Bass-style diffusion process. (A Bass diffusion will tries to measure the different effects of early adopters with late adopters, with the result that the path to the full penetration of the new product can take several different paths). If it is true that learning has value (and it is true), then we would expect to see very rapid experimentation with new products, leading to a very rapid achievement of the steady state penetration.
That isn't what we see, typically. And one really good reason why is because of switching costs. If consumers havev switching costs, the value of learning has to be weighed against those costs, and the possibility that you will learn you don't like the new product and have to incurr the cost of switching back to the oringinal product.
So, it's risky and dynamic and forward-looking. Turns out, it's pretty important, too. According to Osbourne, ignoring learning will lead to models that underestimate own-price elasticity of new products by 30%, while ignoring switching costs will lead to underestimates of own-price elasticity of up to 60%.
So, it's a pretty big deal, since a firm could spend hundreds of millions introducing a new product and it is pretty important to get the pricing right. So, I'll be blogging some insights from the paper and looking for applications to various industries.
