ABSTRACT:
Increasingly, durable goods have embedded software and are technologically tethered to the vendor’s server through this software, be it digital products such as smartphones or predominantly non-digital products such as automobiles and tractors. Tethering can enable the vendor to change the product’s performance or features through software updates, with implications for optimal product policy. We study a monopolist technology vendor’s decision to partially degrade or fully retire their installed base of tethered goods when they release their newer version. Our work presents several novel theoretical contributions with practical implications for industry. Installed base degradation can emerge in equilibrium. To obsolete the previous version, it is no longer necessary for the seller to produce an improved version. Firms may engage in economically suboptimal partial degradation for technical reasons. Firms sometimes engage in suboptimal product obsolescence despite it harming their profit, due to their inability to commit to a no-obsolescence policy. Under some conditions the seller’s commitment problem could cause them to offer excessive durability. Our work suggests important policy guidelines: when releasing new models, firms should consider releasing updated versions of their older operating systems, and allow existing customers to opt out of significant software upgrades, other than essential security patches.
Key words and phrases: Tethered goods, durable goods, economic analysis, analytical modeling, innovation, product upgrades, product obsolescence, embedded software, product policy, backward compatibility