Sustaining vs. Disruptive Technology: Industry Equilibrium under Technology Evolution

We study a special type of technology evolution, referred to in the literature as disruptive technology vs. sustaining technology. In general, “old” products based on sustaining technology are perceived to be superior to the “new” ones based on disruptive technology. However, the latter have distinctive features that allow them to attract an exclusive set of customers. Examples include laser printers vs. inkjet printers, landline services vs. VoIP phones, etc. Our study analyzes industry equilibria in a model with an incumbent and an entrant that have heterogeneous product-offering capabilities: the incumbent can offer either or both types of products, while the entrant can only offer new products. Firms make capacity, pricing, or quantity decisions that maximize their ex-ante profit. Within this framework, we analyze deterministic games with perfect information and stochastic games with uncertain valuation of the disruptive technology. Our results provide threshold conditions that assist the incumbent firm in identifying the right product portfolio. We show that a failure to recognize the opportunity for adopting disruptive technology-based products may lead to an unnecessary price war between the two types of products. In addition, we show that old products exit the market when their prices become too high for their customers, rather than when they become too low for their manufacturers. Our analysis of the effects of uncertainty implies that capacity usage decreases with the degree of uncertainty when firms adopt ex-post pricing (Bertrand-type competition). In addition, overinvestment and over-production are likely to occur when the level of uncertainty is high and/or marginal costs are low. However, if the firms postpone decisions on product types (Cournot-type competition), the total production quantity will not be affected by the degree of uncertainty.