Market Performance and Competition: A Product Life Cycle Model

Market Performance and Competition:
A Product Life Cycle Model

Claudia Werker

Diskussionspapier Nr. 10/00
August 2000

---

---

MARKET PERFORMANCE AND COMPETITION:
A PRODUCT LIFE CYCLE MODEL*


Claudia Werker


Abstract


The paper introduces a new simulation model of market dynamics by integrating several
concepts of evolutionary economics. In the course of market evolution various changes
take place of which the emergence of consumers’ preferences and of the knowledge that
is needed to meet these preferences with appropriate products are the most important
ones. In order to model the market evolution and the resulting changes, Dosi’s concept
of technological paradigms and Winter’s concept of technological regimes are
integrated into a product life cycle model. The simulations performed with this model
help to understand how the dynamics of market evolution shapes market performance
and competition. The results of the simulation runs show a much more differentiated
picture than economic intuition suggests. Moreover, it gives useful hints for innovation
policy.


Keywords:
Market Evolution, Product Life Cycle, Technological Paradigms, Technological
Regimes, Simulation Model.

JEL-Classification

L10, O33


Address of correspondence:
Dr Claudia Werker
University of Greifswald
Chair of Economics and Growth
Structural Change and Trade
Friedrich-Loeffler-Straße 70
D-17487 Greifswald, Germany
Tel:
0049 (0) 3834 86 2487
Fax: 0049 (0) 3834 86 2489
e-mail: werker@uni-greifswald.de

* The simulation results presented here were improved by stimulating discussions with Rainer Voßkamp
and Joachim Schwerin. I like to thank them as well as Sindy Holschumacher, Maja Mende, Tilman
Schmidt, Frank Stummer, and Berit Wende who helped me with the time-consuming and tedious process
of generating the simulation results. All remaining errors are of course my own.

---

---

Market Performance and Competition: A Product Life Cycle Model
1

1. Introduction

Markets provide a variety of different environments that seem to influence competition
and performance in different ways. Detailed knowledge of how market environments
affect competition and performance is crucial for firms as well as for policy makers.
Whereas firms can derive their strategies from this knowledge stock, e.g. to make profit
and to survive competition, policy makers are enabled to identify problems with regard
to the nature of competition, especially situations in which the exploitation of
consumers is likely. Although existing theoretical and empirical results provide a very
confusing picture about the differences between markets, the following analysis shows
that it is possible to gain a differentiated picture of how market environments affect
competition and performance within an evolutionary model of market dynamics.

One promising starting point is to look at the way in which innovation is
generated and organized in markets. The most prominent analysis of the generation and
organization of innovation was provided by Schumpeter. In his book “Theory of
Economic Development”, published first in 1911, Schumpeter described a person who
is at the core of the emergence of innovation: the entrepreneur. Usually this
entrepreneur is not the person who invents something but the one who implements new
combinations in markets (Schumpeter, 1911/1987, 124-139). Interestingly, Schumpeter
changed his mind in his book “Capitalism, Socialism, and Democracy”, published first
in 1942. Here, he claimed that due to the automation of innovation processes,
entrepreneurs do not play an important role in these processes anymore (Schumpeter,
1942/1980, 213-216). And yet - Schumpeter seems to be wrong in 1911 as well as in
1942, because neither do we face an economy of only small innovative entrepreneurs
nor do we only see big firms with automated innovation processes. At the beginning of
the 21st century, small, medium-sized and big enterprises widely coexist. Therefore, the
question has to be answered why we face a variety of firms that differ, especially with
regard to their innovation procedures. At the outset of an answer is the insight that
Schumpeter’s different opinions in 1911 and 1942 show two different states of firms
that emerge in the course of market evolution. Although the automation of innovation
processes is not a feature of a mature economy, it seems to be a feature of a mature
market (see Chapter 2.).

---

Market Performance and Competition: A Product Life Cycle Model
2


Thus, the question at the core of the analysis of market performance and
competition is: Why does the generation of innovation become automated during
market evolution, so that the market turns from a new into a mature one, and what do
the resulting changes mean for market performance and the nature of competition. In
order to answer these questions, the paper is organized as follows. First of all, the
concepts of technological regimes, technological paradigms, and product life cycles are
integrated (Chapter 2.). In Chapter 3., the idea of the model and its structure are
developed. As the model is solved by simulations, the specification of the parameters
and the results are summarized in Chapter 4. Some policy implications as well as
implications for future research round the paper (Chapter 5.).

2. Product Life Cycles, Technological Regimes, and Technological Paradigms

The simulation model developed in the following is based on three theoretical pillars:
product life cycles, technological regimes and technological paradigms. The well-
known product life cycle approach describes the changing features of markets during
their evolution. It may therefore serve as the theoretical framework within which the
automation of innovation as a market phenomenon can be explained. In the beginning
of a product life cycle, the consumers’ preferences are not yet clearly defined.
Moreover, firms have not yet agreed upon the kinds of knowledge that should be used
to meet these blurred preferences. Therefore, many firms with a variety of knowledge
enter the market in this stage. In the course of time, the consumers’ preferences become
clearer and the knowledge used to generate innovation is relatively agreed upon, so that
the generation of innovation finally becomes automated.

There exists a lot of empirical evidence that underpins this concept. Geroski
shows that market entries occur in waves that typically have their maximum in early
stages of the product life cycle (Geroski, 1995, 425f). In the analysis of Klepper/Graddy
most of the analysed 46 products show the regularities predicted by the product life
cycle (Klepper and Graddy, 1990, 28-35): The number of firms starts from a low level
and then increases considerably. Subsequently, a sharp shakeout-stage of firms follows,
so that the number of firms acting in the market decreases. The industry output displays
the highest growth rates in the beginning of the product life cycle; these growth rates

---

Market Performance and Competition: A Product Life Cycle Model
3

decrease and ultimately become zero when the market matures. The industry price
decreases with high rates at the beginning of the product life cycle. Afterwards the price
decrease slows down and becomes zero when the market matures. This pattern is also
supported by several other studies (cf. Klepper, 1997, Agrarwal, 1997, Klepper/Simons,
1996, Utterback, 1994, 79-99, Utterback/Suárez, 1993, and Carroll/Hannan, 1989, 417-
423).

A crucial characteristic of the product life cycle approach is that markets change
from being favourable for entrants to being favourable for established firms. The aim of
this paper is to show how this phenomenon can be modelled endogenously.1 In order to
do so, two additional concepts will be used here: the concepts of technological regimes
and of technological paradigms. Two technological regimes which characterize
different market environments can be distinguished: Under the entrepreneurial regime,
innovative market entry is favoured by the fact that there exists a number of specific
opportunities to exploit the profit opportunities of markets (Winter, 1984, 297). These
profit opportunities are limited because only specific firms have access to the
knowledge that is relevant for the market. This is due to the fact that innovative market
entry does not only require knowledge about technology and products but also about the
specific circumstances of the respective market. For this reason, suppliers of inputs or
consumers of outputs appear relatively often among those companies which enter the
market. In contrast, the market environment under the routinized regime is totally
different. Here innovation by established firms is favoured because the cumulative
character of the market relevant knowledge becomes crucial which result in increasing
returns to scale. Moreover, knowledge is protected by secrecy or patent protection, so
that potential entrants face growing difficulties to gain access to the relevant knowledge
and to compete with the established firms (Winter, 1984, 296).

This distinction of markets according to the environment for innovation by
different types of firms is corrobated by empirical studies as well. Using the data of 4.5

1 Product life cycle models already exist. Yet, in these models the change of environment from a new to a
mature market is usually modelled exogenously (see e.g. Jovanic/MacDonald, 1994). An exception is the
model by Klepper where “(t)he advantage of size in process R&D causes firm process R&D to rise over
time and eventually puts entrants at such a cost disadvantage that entry is foreclosed” (Klepper, 1996,
580). Klepper’s takes the view that the product life cycle is driven merely by the supply side (Klepper,
1996, 562). In contrast, the model presented here is not only a simulation model but it also provides a
view that allows to integrate supply and demand side.

---

Market Performance and Competition: A Product Life Cycle Model
4

Mio. firms in the US-Small Business Data Base from 1976 until 1986, Audretsch was
able to show that significantly more firms entered the markets that could be defined as
entrepreneurial than markets that could be defined as routinized (Audretsch, 1995, 15f
and 62). Similar results were derived by Malerba/Orsenigo. Using patent data of US-
American, German, French, British, Italian and Japanese firms in 49 different sectors in
the period between 1978 and 1991, they reached the conclusion that in some industries
innovation by market entrants were favoured whereas in others more innovation were
generated by established firms (Malerba/Orsenigo, 1996, 454f).

The notion of technological regimes can very well underpin the product life cycle
approach. By integrating both regimes a whole market evolution can be derived,
because the entrepreneurial regime shows the evolution of a new and the routinized
regime that of a mature market. This means that the entrepreneurial regime is a market
stage that is followed by the routinized regime. As a consequence, the question why and
how markets change from an entrepreneurial regime to a routinized one has to be
solved. This explanation can be provided by the third pillar of the model derived here:
the concept of technological paradigms. A technological paradigm can be characterized
by some basic artefacts and a couple of technological paths that provide information on
future research possibilities (Dosi, 1988, 1127, and Dosi, 1982, 151-153). It does not
only define a research field but also gives directions for the search for new solutions as
well as for appropriate tools. These directions of research are called technological paths.
When firms follow these paths, new possible solutions can be found. Therefore,
innovations within a paradigm are generated in an ordered and accumulative way. These
innovations are called incremental, because an ex-ante idea about their possible
outcomes and implications exists. In contrast, radical innovations are connected with
intrinsical uncertainty, because they always cause a change of paradigm, so that even
experts are not able to prognosticate their possible outcomes and implications. In the
following, it is assumed that whereas in the beginning of the entrepreneurial regime
there exist a couple of possible technological paradigms that may contribute to meet
consumers’ preferences, at the end of the entrepreneurial regime consumers do only
accept products manufactured under one paradigm; this is called the dominant
paradigm. Due to the emergence of a dominant paradigm, the market changes from the
entrepreneurial to the routinized regime; a switch which can thus be explained here

---

Market Performance and Competition: A Product Life Cycle Model
5






Figure 1

---

Market Performance and Competition: A Product Life Cycle Model
6

endogenously within the model, the details of which are described in the following
chapter. The integration of the three theoretical pillars into the model is depicted in
Figure 1.

3. The Model
3.1 The idea of the model

In order to derive concrete results for market performance and competition in the
following a model is developed that produces patterns of market evolution according to
the product life cycle approach. The model is formalized by integrating the concept of
technological regimes with that of technological paradigms. To do so, a totally new
innovation mechanism is introduced here into the basic model by Winter (1984). This
new mechanism uses Dosi’s idea of technological paradigms (Dosi, 1982 and 1988).

Winter (1984) distinguished between innovation and imitation to model
differences in innovation efforts and outputs. However, a pure imitation takes only
place exceptionally, because it always requires adaptations to the specific situation and
environment of the firm. Consequently, imitations usually also have innovative
elements. Compared with Winter’s approach the new innovation mechanism that is
based on Dosi’s concept of technological paradigms (Dosi, 1988 and 1982) has two
advantages: First, it provides an endogenous mechanism that explains why the market
changes from the entrepreneurial to the routinized regime: Only when a considerable
part of demand is satisfied by the production from one paradigm, this paradigm is
established as the dominant one and the market becomes mature. The second advantage
of this new innovation mechanism is that it explains better why the entrepreneurial
regime is favourable to innovative market entry whereas the routinized regime is
favourable to innovation by established firms. Within the entrepreneurial regime,
innovative market entries can easily take place with the help of a radical innovation. In
contrast, within the routinized regime market entrants have not only to generate a
radical innovation but they also have to find the dominant paradigm with a productivity
level that is competitive. Therefore, it is much more difficult for them to enter under the
routinized regime and most innovations are generated by established firms.

---