Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
  • How do you encourage speedier adoption of your product or service?
  • How do you increase the value your product or service creates for your customers?
  • How do you extract more of the value created by your product or service for yourself?

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Smartphone manufacturers, such as Apple and Samsung, have thrived for the past fifteen years using a specific business model that involves

(i) Swiftly releasing next generation products that contain significant advancements over previous generations of products, and

(ii) Selling next generation technologies at a premium.

However, more recently, sales of used and refurbished older-generation-technology products have cut into sales of latest-generation-technology products. This analysis examines the game between sellers of new products and sellers of used and refurbished products.

 

Figure 1

used tech game

Figure 2

timeline

 

Players in the Used Technology Game

Manufacturers of New Technology Products

Objective: Maximize profits from sales of new and refurbished technology products to Customers.

Actions

  • Sell new technology products to Customers
  • Accept trade-ins of used technology products from Customers
  • Refurbish used technology products
  • Sell refurbished technology products to Users

 

Refurbishers of Used Technology Products

Objective: Maximize profits from sales of refurbished technology products to Customers.

Actions

  • Buy used technology products from customers
  • Refurbish used technology products
  • Sell refurbished technology products to Users

 

Customers

Objective: Maximize utility from

(i) Purchases of new, refurbished and used technology products from Manufacturers, Refurbishers, and Customers, and

(ii) Sales of used technology products to Refurbishers and Customers.

Actions

  • Buy new technology products from Manufacturers
  • Buy refurbished technology products from Manufacturers and Refurbishers
  • Buy used technology products from Customers
  • Sell used technology products to Refurbishers and Customers

 

Society

Objective: Maximize social welfare, which is the sum of

  • Manufacturers’ profits
  • Refurbishers’ profits
  • Customers’ utility
  • Environmental waste
  • Resource depletion

 

Model of the Game

Price of New Technology Products

P1                   Price of new 1st-generation technology products

P2                   Price of new 2nd-generation technology products

PNG                Expected Price of new next-generation technology products

Pt – P(t-n)        Price premium of new t-generation technology product over new (t-n)-generation technology product. Price premium is larger when more-advanced technologies provide significant benefits over past-generation technologies

Discounts

δn    Discount on used products from n-generation technology, capturing depreciation.

  • Discounts, δ, are large when
    • Used products are bad substitutes for new products
    • Parts wear out quickly
    • Technology advances provide large benefits

σn    Discount on used or refurbished products with n-generation technology, capturing stigma of buying used or refurbished technology products, rather than new products.

  • Discount factors, σ, are large when used or refurbished products are bad substitutes for new products
  • Who wants what
    • Manufacturer wants high σ so Customers buy new, not used or refurbished products
    • Refurbisher wants low σ so Customers buy refurbished, not new, products

Price of Refurbished Technology Products

P1 - σ1            Price of refurbished 1st-generation technology products

P2 - σ2            Price of refurbished 2nd-generation technology products

Price of Used Technology Products

P1- σ1 - δ1       Price of old 1st-generation technology products

P2 - σ2 - δ2      Price of old 2nd-generation technology products

Refurbisher's Profits

CREFURB_n      Cost of refurbishing product with n-generation technology

Pn - σn - σn      Cost of buying used n-generation technology

Pn - σn             Price of refurbished n-generation technology

Πn  =  (Pn - σn) – (Pn - σn - δn) - CREFURB_n  =  δn - CREFURB_n

 

Issues

Rate of Technological Change

When Technology is evolving rapidly, next generation products can be released quickly and generate large price premiums. The technology in products becomes obsolete before the product's parts wear out. Old/refurbished products generate much lower prices than latest generation technology products. Customers upgrade more often, so the social costs increase.

When Technology is evolving slowly, older products maintain their value longer. There is less demand for latest-generation-technology products. Manufacturers face more competition from used and refurbished products.

Figure 3

matrix

An interesting phenomenon with respect to technological evolution is this. Once technology products reach a certain threshold of being able to meet peoples’ basic needs, then Manufacturers have a problem. Newer generation technology products may very well have plenty of capabilities that older generation technology products don’t have. But once technology products reach a level of being good enough to satisfy the needs of enough people, then Manufacturers end up shrinking their market of profitable Customers to the smaller subset of Customers who want more bells and whistles.

Strategic Pricing

P2 – P1 is the price differential between the current generation of technology products and the last generation technology products. Manufacturers can increase the price premium, either by

(i) Increasing the price of the current generation technology product, P2. To do this, the Manufacturer must increase the relative quality of newer products, Quality2 – Quality1.

(ii) Dropping the price of older products, P1. You often see Manufacturers drop the price of last-generation-technologies products when they release the next generation technology products. Dropping the price of last-generation-technologies products also makes prior-generation-technology products less attractive to Customers. This decreases Manufacturers' costs to the extent that it cuts their need to maintain older-generation-technology products.

Trade-Ins

Manufacturers accept trade-ins of used products from Customers to reduce the cost to Customers of upgrading to next-generation technology products, thereby encouraging upgrades before old products wear out. That is, Manufacturers use trade-ins as a means of reducing the switching costs of Customers. (This is a topic I cover in my book)

Manufactures refurbish trade-in products and re-sell them to Customers. To the extent that Manufacturers control the market for refurbished products, they can control supply and set prices of refurbished products strategically, that is, relative to prices of new products, to maximize profits of total sales of new and refurbished products.

Timing of Next-Generation Technology Product (NGTP) Releases

Faster releases of NGTP enable Manufacturers to generate new price premiums. But faster releases cannibalize on sales of last-generation technology products (LGTP). Manufacturers need NGTP to be significantly better than LGTP, so that new premiums will be large enough to compensate for product cannibalization.

The longer the time until NGTP, the greater will be the stock of used and refurbished products to compete with sales of new products. So Manufacturers want short periods between new releases. 

So there is a tension here: faster releases enable new premiums, they limit the size of used product competition, but they cannibalize on sales of older-generation technology products.

Cost of Refurbishing

Manufacturers want costs of refurbishing used products to be high. In this case, Refurbishers will have to sell refurbished products at high prices to cover the costs of refurbishment. With high prices of refurbished products, Customers may as well buy new products.

Manufacturers have been increasing the costs of refurbishing used products using the following techniques:

From Emily Matchar, “The Fight for the ‘Right to Repair’”

  • Restricting Customers to having products fixed at licensed repair shops.
  • Restricting Repairers from repairing products by using digital locks or copyrighted software.
  • Not releasing specs or parts for products on the market.
  • Manufacturers have also been increasing costs by “tampering” with production methods.

From Timothy W. Martin and Drew FitzGerald, “Your Love of Your Old Smartphone Is a Problem for Apple and Samsung”

  • Enabling Customers to lease, rather than buy, new phones.
  • Slowing the performance of older products.

Nick Statt, “Why Apple and other tech companies are fighting to keep devices hard to repair”

The company [Apple] makes it difficult to repair its products by using proprietary screws, unibody enclosures, and other manufacturing and design techniques that make it so only Apple or computer repair experts can easily take them apart. The company also makes it notoriously difficult to replace its batteries, by gluing them to other components and burying them beneath layers of complex, sensitive parts. Instead, Apple incentivizes consumers to trade in or discard models that are just 18–24 months old for newer ones.

Methods for Reducing Waste

  • Require Customers to pay a large deposit that’s refunded when Customers recycle used products. However, need deposit to go to recyclers, not Manufacturers; otherwise, Manufacturers benefit when Customers throw away products and forfeit deposits.
  • Establish requirements that ewaste be recycled.
    • Can use Customer deposits as per last bullet point.
    • Can have Manufacturers responsible for Customers’ ewaste. If Manufacturers are required to pay fines for products lost-to-follow-up, they will have an incentive to encourage Customers to return used products to Manufacturers. This also decreases the size of the market for used products to compete with sales of new products. Good for Manufacturers, good for environment.

Depreciation

Refurbishers’ Profits from sales of n-generation technology products: Pn = (Pn - σn) – (Pn - σn - δn) - CREFURB_n = dn - CREFURB_n

Depreciation has two components

(i) The rate at which parts wear out

(ii) The rate at which technology becomes obsolete

Figure 4

depreciation pref

Refurbishers want technology products to have high rates of depreciation where parts wear out, but they want low rates of improvement in new technology, because technological evolution decreases the value of the products Refurbishers refurbish. Refurbishers essentially renew the value of used products to their original level by the amount of depreciation. So if depreciation is high, there’s more room for Refurbishers to add value.

Manufacturers also want high rates of depreciation, but they want it on the technology evolution component. Faster evolving technologies enable Manufacturers to release next-generation-technology products with high prices than current-generation technology products. Higher rates of technological evolution also decrease the value of used and refurbished earlier generation products relative to next-generation products.

Stigma

Manufacturers want large stigmas associated with buying used or refurbished products, so people will buy new products instead. Refurbishers want small stigmas so people will buy more refurbished products.

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