Markov Perfect Equilibrium, Discrete Choice Model and the Innovator’s Dilemma under the Customers’ Preferences Uncertainty

This paper investigates the equilibrium investment policies of two different firms under customers’ preferences uncertainty. The incumbent firm, which owns a superior old technology, produces merchandise that can satisfy current customers at the beginning of the investment game. The startup firm, which possesses an inferior old technology, does not capture the customers’ satisfaction but it has a possibility to cultivate a new technology that can attract the customers in the future if the customers’ preferences are changed. We consider two types of equilibria in our valuation model. The first one is a price equilibrium at each time point derived from the Bertrand competition. To represent customers’ diversity and products differentiation we use a discrete choice model. The other one is a Markov perfect equilibrium where each firm have options to invest either in the old technology or in the new technology depending on customers’ preferences which are modeled as a Markov process.