Production, Manufacturing and Logistics
Optimal product rollover strategies

https://doi.org/10.1016/j.ejor.2005.04.031Get rights and content

Abstract

As product life cycles shortened, many firms introduce new products and phase out old products frequently. To plan for a successful product rollover; i.e., introduce a new product and eliminate an old product successfully, a firm needs to determine the prices of both products as well as the time to launch the new product and the time to phase out the old product. In this paper, we develop an analytical model to analyze the profits associated with two product rollover strategies: single-product rollover and dual-product rollover. The single-product rollover strategy calls for simultaneous introduction of the new product and elimination of the old product. For the dual-product rollover, we introduce the new product first and then phase out the old product eventually. We determine the optimal prices of both products as well as the optimal time to execute these product rollover strategies. Moreover, we determine the conditions under which the dual-product rollover strategy is optimal.

Introduction

With increasing emphasis on market leadership and shareholder value creation, firms view new product development as a source for obtaining growth, renewal and competitive advantage. Due to speedy technological development and variety seeking consumers, many firms introduce many new products frequently. As more new products appear in the market, many old products could become obsolete, and hence, they should be phased out. Consequently, we have witnessed shorter product life cycles in many industries such as personal computers, cellular phones, electronics, various types of toys, etc. As product life cycles shortened, firms need to address various strategic issues when managing a product rollover (i.e., introduce a new product and phase out an old product):

  • 1.

    Timing Issues. When shall we phase out the old product and introduce the new product? Should we phase out the old product and introduce the new product simultaneously or should we introduce the new product first and then phase out the old product later on?

  • 2.

    Pricing Issues. What would be the pricing mechanism for the old product (before and after the introduction of the new product)? What would be the pricing mechanism for the new product (before and after the elimination of the old product)?

  • 3.

    Contingencies. What kind of contingency plan should we consider in anticipation of certain plausible events (e.g., competitors introduce new products, competitors dropped prices of old products, technical problems associated with our new products, having too much inventory or stockouts of our old products)?

The answer to the above questions would be helpful to decision makers when managing product rollovers. As an initial attempt to develop a mathematical model to analyze issues related to product rollover, we shall focus our analysis on the timing and pricing issues in this paper.

The time to phase out the old product and the time to introduce the new product are critical for managing product rollovers successfully. The tradeoff is as follows. If one phases out the old product too soon, then the manufacturer may lose potential customers who intend to buy the old product. If one phases out the old product too late, then the new product may suffer from poor sales due to the late withdrawal of the old product. If one introduces the new product too early, then it may cannibalize the demand for the old product. However, if the new product is launched too late, the novelty of the new product is diminished. In the same vein, the price of the old and new product during each phase of the product rollover is another important product rollover issue. The tradeoff is as follows. If the price of the old product is too low, then it will cannibalize the demand for the new product. If the price of the old product is too high, then it may cause the price of the new product to become even higher. As such, both products may suffer from lower demands. Based on a study of 126 US durable goods companies, [5] showed that 40% of new products failed after being introduced to the market. This observation has motivated us to develop a formal model for analyzing the timing and pricing issues arising from managing a product rollover.

In this paper, we present a model for determining the time at which the new product is introduced as well as the time at which the old product is eliminated. Our model also determines the price of both products before and after the introduction of the new product. We consider two specific product rollover strategies: single-product roll and dual-product roll. Single-product roll plans to phase out the old product and introduce the new product simultaneously. Clearly, single-product roll allows only one product to be available in the market during any given point in time. For example, Hewlett-Packard used the single-product roll when they replaced DeskJet 500 printers with DeskJet 510 printers. Dual-product roll calls for introducing the new product first and then phasing out the old product. As such, dual-product roll allows the co-existence of both old and new products over a certain period of time. An instance of a dual-product roll strategy is when Intel replaced the DX-486 chips with the Pentium. To simplify our analysis, we shall assume that both old and new products will be sold in the same geographical region and through the same channel. We analyze the optimal timing for introducing new products and for phasing out old products. Also, we determine the conditions under which a dual-product roll is preferred over a single-product roll. Moreover, we compare the optimal prices of both products during different time periods.

Our model allows us to examine various tradeoffs between the introduction of a new product and the elimination of an old product. The advantages of our model are as follows. Firstly, our model recognizes the interrelationship between the new and the old products that is often present in new product launch. To our knowledge, ours is the first attempt to address such tradeoffs analytically. Secondly, our model extend the literature by presenting a formal analysis of the optimal product rollover strategies, in terms of both timing and pricing. Our model yields the following policy insights:

  • It is optimal for the firm to choose a dual-product rollover strategy when the marginal costs for the old and the new products are similar.

  • When the firm chooses a single-product rollover strategy, the optimal price of each product is increasing in its own marginal cost. When the firm chooses a dual-product rollover strategy, the optimal prices of both products would depend on the marginal costs of both products, the ratio of the demand for the new product to the demand for the old product, as well as the inter-product price sensitivity.

  • When the firm chooses a dual-product rollover strategy, the optimal market share of each product depends on the marginal cost difference between the two products.

  • When it is optimal for the firm to choose a dual-product rollover strategy, the optimal duration for the firm to sell both products depends on the loyalty factors associated with the old product and the new product.

The results are of interest as not all of them are intuitive. Moreover, the explicit representation of the tradeoffs in the model can stimulate further empirical research.

The rest of this paper is organized as follows. A brief review of related literature is provided in Section 2. In Section 3, we present a model that captures the essence of issues related to product rollovers. We analyze our model for the single-product rollover strategy and dual-product rollover strategy in Sections 4 Single-product roll strategy, 5 Dual-product roll strategy, respectively. Specifically, we analyze the optimal pricing of both products and the optimal time to introduce the new product and the optimal time to phase out the old product. In Section 6, we determine the conditions under which a dual-product roll strategy is preferred to a single-product roll strategy. Various managerial insights are also provided. We discuss and propose future research direction in Section 7. All proofs are provided in Appendix.

Section snippets

Literature review

Previous work on new products have focused primarily on the new product development process. Two approaches to technology selection were analyzed in [8], namely, an approach that involves a prospective technology and a sufficient design approach which uses a proven technology. In [1], the authors presented a new product development process under market uncertainty. They recommended that to maximize profits, a firm should adjust its product definition process to the prevailing level of market

Model formulation

Consider a market in which a manufacturer has been selling an old product for some time. To stimulate sales and increase profit, this manufacturer has developed a new product. The manufacturer is now contemplating the idea of introducing this new product and phasing out the old product within a time window [0, T]. We assume that the new product is ready to be introduced and the old product can be phased out anytime within this time interval. To model the timing issue associated with the product

Single-product roll strategy

Suppose we differentiate the objective function Π(Po1, Po2, Pn2, Pn3, Tn, To) with respect to Po1 and Pn3 separately. Then we can examine the first order conditions and deduce that Po1=12(1a+co)(>co),Pn3=12(1a+cn)(>cn). Also, by substituting Po1 into the portion of demand for the old product (1  aPo1) (Pn3 into the portion of demand for the new product (1   aPn3)) and by substituting Po1 into the profit function for the first time zone Π1(Po1, Tn) (Pn3 into the profit function for the third time

Optimal product rollover prices

Consider the case in which the firm chooses a dual-product rollover strategy; i.e., Tn < To. For any given value of To and Tn (where Tn < To), we have three time zones, namely, [0, Tn], [Tn, To], and [To, T]. For the first and third time zones, we have already analyzed the optimal price of the old product in the first time zone and the optimal price of the new product in the third time zone in Lemma 4.1. As such, in this section, we shall focus our analysis on the optimal prices of both products that

Single- versus dual-product roll

In this section, we investigate the conditions under which a dual-product rollover, rather than a single-product rollover, is optimal. First, we consider the special case where the marginal costs co, cn are the same.

Lemma 6.1

Suppose that the marginal costs of the products are the same (i.e., co = cn = c). Then it is optimal for the firm to select the dual-product rollover strategy over the entire time interval [0, T]; i.e., Tn=0,To=T.

The intuition behind the above lemma is quite straightforward. From

Conclusion

In this paper, we have developed a model to examine the timing issue and the pricing issue arising from managing product rollovers. Our analysis enabled us to determine the optimal prices of the old and the new products for different periods of time, when only the old product, only the new product, or when both products are available in the market. Also, we determine the optimal time to introduce the new product and the optimal time to phase out the old product. Furthermore, we have derived the

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