Exogenous and Endogenous Set-up Costs in Markets with Customized Products

In this paper we present a model of spatial competition that highlights firms’ customization strategies in an imperfect competitive environment. The nature of competition in markets with products designed according to consumer preferences is discussed both in a framework of exogenous and endogenous set-up costs. Set-up costs are considered endogenous when technology is such that reductions in variable customization costs are feasible at additional set-up costs. It is shown that when set-up costs are exogenous, strategic interaction induces firms to choose the most efficient customization technology, though the latter entails a reduction in prices and profits and a more concentrated market structure. When set-up costs are endogenous, the incentive to choose strategically a more efficient customization technology depends on the possibility to cheaply transfer the customization costs into the set-up costs. This explains why customization is more frequently observed for information goods and in digital markets.