Competing with Co-Created Products

The practice of firms co-creating products and services with their customers has a long history in business markets and, with advances in information technology, is now gaining increasing popularity in consumer markets as well. In this research we study the incentives of competing firms to co-create. 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, (1) endogenous pricing and effort choice by the upstream supplier and (2) endogenous pricing and effort choices by the downstream firms. 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 than they themselves could produce. 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 products to all firms. Our model captures this tension and offers several insights.First, we show that, when firms compete in the end-consumer market, the supplier can exert lower innovation effort when it co-creates with more firms. This result complements the existing literature that shows that, without competition between firms, a supplier is always better off and exerts more effort when it co-creates with more firms.Second, we show that in the 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 competition between the firms is moderate.Third, we find two types of asymmetric equilibria. For moderately low degrees of competition between firms, all parties prefer the asymmetric outcome. For moderately high degrees of competition, 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 obtains, beyond that preferred by the firms themselves.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.