The aim of this paper is to address how the secondary market affects the strategy of the manufacturer’s new product introduction by using the optimization method. To do so, we develop a twoperiod model in which a monopolistic manufacturer sells its new durable products directly to end consumers in both periods, while an entrant operates a reverse channel selling used products in the secondary market. We assume that the manufacturer launches a higher quality product in the second period for the technological innovation. We find that the secondary market can actually increase the manufacturer’s profitability and drives the new product introduction in the second period. We also derive the effect of the durability and the degree of quality improvement on the pricing of supply chain partners.
Secondary markets have grown significantly as important transaction channels for durable products, such as used car markets, computer markets, and data storage equipment markets. At the same time, secondary markets that are not directly controlled by the manufacturers of new products have also increased greatly. For instance, in 2005, Computer Business Review [
The rise of secondary markets implies that the primary markets’ manufacturers are facing fierce competition from their secondary markets. Because the existence of resale value for used products facilitates some new products’ consumers turning to buy used products, it results in the decreasing of the newproduct manufacturer’s profitability. Therefore, many manufacturers try to eliminate their secondary markets to alleviate this conflict. For instance, Sun Microsystems, one of the leading firms in the IT server business, deliberately attempted to eliminate the secondary market for its machines worldwide through their pricing and licensing schemes [
In this paper, we develop a twoperiod model in which a monopolistic manufacturer sells its new durable products directly to end consumers in both periods, while an entrant operates a reverse channel selling used products in the secondary market. We assume that, in the second period, the manufacture releases a quality improvement product (i.e., one that is technologically superior to the version introduced in the first period). Our primary objective is to understand the following problems. How does the secondary market affect the manufacturer’s profitability and new product introduction in durable goods industry? What is the effect of the durability and the degree of quality improvement on the pricing of supply chain partners?
The rest of this paper is organized as follows. In Section
Our paper belongs to the larger literature on durable goods pricing and new product introduction. There are two streams of literature relevant to our research.
The first stream of literature deals with durable products in the secondary market domains. Earlier research about secondary markets in the field of economics focuses on the theory of auctions [
Another stream of literature related to this paper deals with new product strategies for durable products. Levinthal and Purohit [
We focus on a dynamic, twoperiod model in which a monopolistic manufacturer directly sells its new durable products to the end consumers, while an entrant in the secondary market sells used products (i.e., which were bought back from the firstperiod customers, cleaned and tested, and resold) to the end consumers (see Figure
Twoperiod model framework.
Like most papers [
Before processing a detailed analysis of this model, we make the following assumptions that build on assumptions commonly used in the durable goods literature (e.g., [
The product depreciates with use.
In our model, a durable product provides two periods of service. After a consumer purchases a new product in period 1, the product depreciates with use and becomes a used product in period 2. The rate of depreciation of a product depends on its durability, which is parameterized by
Consumers are heterogeneous in willingness to pay.
We assume that consumer types are distributed uniformly in the interval
Consumers are strategic.
We assume that consumers take into account the future resale value of the product in making their purchase decisions. This is facilitated in practice by the existence of consulting companies that offer resale value forecasts and it is consistent with the durable goods literature. Our equilibrium characterization is based on rational expectations of consumers about future prices.
Consumers do not sell their used products directly to each other.
This assumption reflects the current practice in the used products market, such as used PCs and used car markets, where most used equipment, before it can be resold, requires testing and the replacement of wearable parts that the consumers do not have the technical capability to perform (see, [
In the second period, the manufacturer introduces a new product that is technologically equivalent or superior to the one introduced in the first period.
In our model, we assume that, in the second period, the manufacturer introduces a new product that is technologically equivalent or superior to the one introduced in period 1. For instance, an upgraded version might have a faster central processing unit or a bigger memory. To capture the increased consumer willingness to pay for the new product due to this technology improvement, we assume that a consumer with a willingness to pay
To maximize utility, a firstperiod consumer will purchase in the first period if the net utility from buying the good is greater than the utility of not buying the good (which is normalized to zero). Thus, the utility of buying a new good in the first period is
In the second period, there are three mutually exclusive and exhaustive consumer segments (see Figure
Purchase behavior of different segments.
Based on the purchase decisions (A1), (A2), (A3), and (A4), we can determine the critical indices shown in Figure
In this section, we analyze the model of a monopolistic manufacturer directly selling his new durable products to the end consumers in both periods and an entrant selling used products in the secondary market in the second period. In the first period, the manufacturer sells the firstgeneration new products. In the second period, he sells the secondgeneration new products to consumers for the technological innovation. We provide a characterization of the equilibrium and focus on the analytical results along the following dimensions. (a) How does the secondary market affect the strategy of the manufacturer’s new products introduction? (b) What is the impact of the durability on the pricing of new products?
To ensure that we find a subgame perfect Nash equilibrium, we follow the method of backwards induction. We first solve the entrant’s optimization problem and assume rational expectations on the part of the consumers. Letting
The manufacturer’s problem is to maximize the total profit over the two periods with respect to
The manufacturer’s firstperiod optimization problem is
The equilibrium decisions for the channel partners are given in Proposition
Equilibrium decisions for the channel partners in model are
Proposition
The price of the firstgeneration new and used products increases in the durability of products
The higher durability,
Changing trends in price.
The price of the firstgeneration and secondgeneration new products and the firstgeneration used products all increases in the degree of quality improvement
The intuition behind this result is as follows. When the secondary market exists, more firstgeneration buyers prefer to buy a secondgeneration new product in the second period, because they get a residual value to inspire them to buy a secondgeneration new product by selling their used product to the secondary market. Hence, the existence of the secondary market stimulates more firstgeneration buyers to replace their used product with a secondgeneration new product. In other words, the manufacturer has a higher opportunity to charge a higher price. On the other hand, in order to encourage more firstgeneration buyers to buy a secondgeneration new product in the second period, the manufacturer prefers an active secondary market for the firstperiod buyers to unload their old products. Therefore, to achieve this result, the manufacturer will increase its price of the firstgeneration new product, because improving the price of the firstgeneration new product results in two effects on the secondary market. First, on the demand side, a higher firstgeneration price will increase the future demand for the firstgeneration product in the secondary market because more firstperiod customers will wait till the second period to buy the old product on the secondary market. Second, on the supply side, the supply of the firstgeneration product on the secondary market will be reduced. The reason is that the firstperiod price is higher. Hence, fewer units are sold in the first period. These effects reinforce each other and lead to a higher price in the secondary market. In addition, we illustrate the changing trends of the price of the firstgeneration and secondgeneration new products and the firstgeneration used products through a broad numerical study. Table
Different price value for parameter

 

1.1  1.2  1.3  1.4  1.5  1.6  1.7  1.8  1.9  

0.8284  0.8296  0.8305  0.8312  0.8318  0.8323  0.8327  0.8331  0.8334 

0.3030  0.3550  0.4066  0.4579  0.5089  0.5598  0.6015  0.6612  0.7117 

0.1054  0.1110  0.1155  0.1191  0.1221  0.1246  0.1268  0.1286  0.1302 
When there is a secondary market, the profit of the manufacturer is increasing in the degree of quality improvement. That is, the existence of the secondary market drives the manufacturer to launch a quality improvement new product in the second period.
To understand this result, one needs to recognize how the secondary market affects the manufacturer’s profitability. On the one hand, because the secondary market offers a resale value to the firstgeneration buyers, more of them buy a secondgeneration new product in the second period. This facilitates for the manufacturer charging a higher price for his secondgeneration new product. On the other hand, if the secondary market exists, the firstgeneration product competes with the manufacturer’s secondgeneration new product in the second period. This cannibalization effect puts downward pressure on the manufacturer’s profitability. Therefore, the net effect of the secondary market on the manufacturer’s profitability depends on which of the two opposing forces is stronger. As the degree of quality improvement of the secondgeneration new product increases, the positive effect of the secondary market on the firstgeneration buyers dominates its cannibalization effect on the secondgeneration new products. Hence, the existence of the secondary market actually increases the manufacturer’s profitability and drives the manufacturer to launch an innovative new product in the second period.
In this paper, we consider a dynamic, twoperiod model in which a monopolistic manufacturer directly sells new durable products to the end consumers, and an entrant sells used products to them. In the first period, the manufacturer sells the firstgeneration new products to consumers. In the second period, he sells the secondgeneration new products to consumers for technological innovation. We assume that the manufacturer does not engage in selling used products in the second period. We examine how the secondary market affects the strategy of the manufacturer’s new product introduction in durable goods industry. The significant difference with the previous research is that we consider the endogeneity of the consumer’s decision and its impact on the demand of consumers, which, we believe, is a novel addition to the literature. In this context, our study brings to light a number of important implications of secondary markets on the new introduction for the durable products. One of the important conclusions is the existence of the secondary market deriving the new product introduction in durable goods industry.
Our model setting assumed a renewable set of consumers. An extension of our model would be set as a nonrenewable market, which is a typical assumption in the durable product literature. Another assumption in our model is that the manufacturer does not engage in selling used products in the secondary market. We can consider the manufacturer selling new and used products, simultaneously. We hope that this work will spur a stream of research regarding the important and everincreasing role that secondary markets play in the durable goods industry, which will serve to provide guidance to marketing managers.
The entrant’s optimization problem is
We consider two subcases according to whether the Lagrangian multiplier
Because the Lagrangian multiplier
We now consider the price of new products in the second period under Case Ea. Replacing the values
The Lagrangian for the manufacture’s secondperiod problem is
We consider two subcases according to whether the Lagrangian multiplier
Solving the system, we have that
Moreover, Lagrangian multiplier
Similarly, we consider the price of new products in the second period under Case Eb. Replacing the values
Now we consider the price of new products in the first period under Case M_{2}a1. Replacing the values
The Lagrangian for the manufacture’s firstperiod problem is
The KuhnTucker conditions for optimality are
We consider two subcases according to whether the Lagrangian multiplier
Solving the system, we have that
Similarly, we consider the price of new products in the first period under Case M_{2}a2. Replacing the values
Similarly, we consider the price of new products in the first period Case M_{2}b. Replacing the values
Based on the above analysis, we obtain that the optimal price of new products in period 1 is
Substitution of
Therefore, the equilibrium decisions for the channel partners are given in Remark
Entrant’s decision is as follows:
Manufacturer’s decisions are as follows.
Period 1:
Period 2:
Refer to Remark
For the sign of
Noting that
For the sign of
Noting that
Following the similar analysis, we have
For the sign of
For the sign of
For the sign of
Noting that
Substituting
The authors declare that there is no conflict of interests regarding the publication of this paper.
This research has been supported by the National Natural Science Foundation of China (71271225 and 71301178), Chongqing’s Natural Science Foundation (cstc2012jjA00036), and the Open Fund of Chongqing Key Laboratory of Logistics (CQKLL12001).