Product Line Extensions and Technology Licensing with a Strategic Supplier

Abstract

In many industries, original equipment manufacturers (OEMs) must obtain critical components from a few powerful suppliers. For example, OEMs that produce information technology hardware typically interact with highly concentrated supply industries that are dominated by a few key participants, e.g. Microsoft, Intel, etc. To the extent that the OEMs are also concentrated, e.g. Dell, Hewlett-Packard, etc., the interactions between the suppliers of critical components and the OEMs are strategic, and have implications for how an incumbent OEM chooses its product line and interacts with potential rivals. We demonstrate that, by adding a low-end product line extension, an OEM can induce a strategic supplier to offer more favorable pricing. Moreover, depending upon the cost structure and relative performance of the product line extension, the OEM may benefit even more from the low-end line extension if it is produced by a rival instead of by itself. Among other things, we show that this can result in a decentralized OEM developing product line extensions that would not be developed in a vertically integrated supply chain.

Keywords: marketing stragegy, licensing, vertical differentiation, product-line design, game theory, competition, strategic effect

JEL Classification: C72, D43, L13, L22