Brand Familiarity and Product Knowledge in Customization

This paper challenges the assumption commonly used in the theoretical literatureon customization that consumers always get their ideal varieties when theypurchase a customized product. I adopt Hotelling's horizontal diffierentiation modelwith two firms competing for a continuum of consumers. Each consumer has amost preferred variety and possesses a certain level of category-specific knowledge.Initially, the firms produce standard products located at the end points of the varietyinterval. Suppose one of the firms offers customization. Consumers familiarwith the brand can easily transfer their needs into appropriate characteristics ofthis brand. Consumers unfamiliar with the brand have difficulty in expressing theirpreferences. Category-specific knowledge is crucial here. Knowledgeable consumersare more capable of analyzing information than less knowledgeable ones, and theproducts they design better match their preferences. The game runs as follows.First, the firms simultaneously decide whether to offer customization, then engagein price competition. I show that while customization makes the products less differentiated, the frictions introduced into consumer co-design activities relax price competition. As a result, customization by one of the firms occurs in equilibrium.