Insurance Claim Operations: The Role of Economic Incentives

We develop a theory of insurance claim settlement whose structure embodies an insurer’s capacity decision and negotiation between the insurer and claimant in an asymmetrically informed environment. We offer a solution to an insurer’s choice of upfront claim settlement amount under a plausible set of assumptions. Implications from theory are tested with a large sample of liability insurance claims collected over two years in the state of Texas and we find that insurer’s deployment of more capacity to handle a claim and longer settlement times occur for claims with more uncertainty. The empirical results also reveal factors relevant to insurer’s operational choices. Descriptive features of a claim, the age of the claimant and attorney representation on the plaintiff’s side are important determinants of the final settlement amount

Selling and Leasing Strategies for Durable Goods with Complementary Products

It has been recognized that when a durable goods manufacturer sells her output, she has an incentive to produce at a rate that will drive down the market price of her product over time. Because anticipation of declining prices makes consumers less willing to invest in owning the durable good, selling can be self-defeating for the manufacturer. If instead, the manufacturer leases her product, she can eliminate her own incentive to decrease the price over time, which allows her to extract larger rents from consumers. In this paper, we investigate how a durable goods manufacturer\u27s choice between leasing and selling is affected by a complementary product that is produced by an independent firm. We show that a durable goods manufacturer who leases her product has an incentive to increase prices (by limiting the availability of her product) in response to the availability of a complement. Since this potential for opportunistic behavior discourages output of the complement, leasing can also be problematic. As a result, the durable goods manufacturer faces a trade-off between leasing, which commits her to not over-produce, and selling, which commits her to not under-produce. Our contribution is to identify this trade-off and show how a durable goods manufacturer can use a combination of leasing and selling to balance its strategic commitment across both its own market as well as the complementary market

Effort, Revenue and Cost Sharing in Collaborative New Product Development

The growing sophistication of component technologies and the rising costs and uncertainties of developing and launching new products now require firms to collaborate in the development of new products. However, the management of new product development that occurs jointly between two firms presents a new set of challenges in sharing the costs and benefits of innovation. While collaboration enables each firm to focus on what it does best, it also introduces new issues associated with the alignment of decisions and incentives that have to be managed alongside conventional performance and timing uncertainties of new product development. In this paper, we conceptualize and formulate the joint-development of products involving two firms with differing development capabilities and examine the implications of arrangements that go beyond sharing of revenues to include sharing of development cost and work. We term these approaches that involve sharing of the development cost and sharing of the development work, investment sharing and innovation sharing, respectively. These cost and effort sharing mechanisms have subtle interactions with the degree to which revenues are shared between firms and the type of development project under consideration. Our analysis shows that investment and innovation sharing are particularly relevant for products with no pre-existing revenues and their benefits also depend on the degree to which revenues are shared between the firms. While investment sharing is more attractive for new to the world product projects with significant timing uncertainty, innovation sharing plays an important role in environments where projects experience product quality uncertainty, firms are similar in their capabilities, and the costs of integration of work across firms can be controlled. Our key contribution involves the modeling of joint work and decision making between collaborating firms and unearthing the complementary role of revenue, cost, and innovative effort sharing mechanisms for new product development. We translate our analytical findings into a managerial framework and illustrate the results with examples from the life-sciences and electronics industries

Consumer Mental Accounts & Implications to Selling Base-Products and Addons

Firms in a variety of industries offer addon products to consumers who have previously purchased a base-product. We posit that consumers, in making their decision whether to purchase an addon that complements the base-product, find a greater need for the value offered by the addon when the “unrecovered” value (i.e., price paid minus the benefits obtained so far) associated with the base-product is higher. We conduct experiments that test the proposed hypothesis, and examine the strategic implications of such consumer decision making to a firm who sells base-product addon pairs. Consistent with our hypothesis, the experiments show that the “unrecovered” value associated with the base-product is positively correlated to a consumer\u27s likelihood of purchasing the addon. Formal modeling of this bias shows that firms may find penetration pricing strategies (such as loss-leader pricing) suboptimal. Furthermore, the identified bias leads to the firm spending more resources toward enhancing the both base-product quality and the quality of the addon, especially so when the addon will be offered before the consumer has a chance to extensively use the base-product. Finally, the effect of competition in the base-product market is also considered

Managing Technology Uncertainty Under Multi-Firm New Product Development

The growing sophistication of component technologies and the rising costs of product development require firms to collaborate in the development of new products by pooling their resources and entering into resource or cost-sharing arrangements. However, the management of new product development that occurs jointly between a technology supplier and its industrial customer presents a new set of challenges. While such vertical collaboration enables each firm to focus on what it does best and achieve certain economies of specialization, it also introduces new issues associated with the alignment of decisions and incentives that have to be managed alongside conventional performance and timing uncertainties of new product development. In this paper, we conceptualize and formulate the co-development of products involving two firms and examine the implications of two collaboration mechanisms found in industrial practice. We term these approaches which involve sharing of the development cost and sharing of the development work, investment sharing and innovation sharing, and find that they have subtle effects on the degree of product innovation and profits of individual firms, depending on the nature and extent of technological uncertainty, product development cost structure, and complementary relationships with other products. We consider both exogenous and endogenous technology uncertainty, and study the impact of investment and innovation sharing on a firm\u27s technology consideration set, product qualities, and profits. Conditions under which firms should consider one mechanism over the other and over single firm product development are proposed. Our analysis shows that, while investment sharing plays an important role in environments with higher levels of technology uncertainty, innovation sharing can result in greater quality improvements and profits if firms are able to manage the distributed product development process more efficiently. We translate our analytical findings into a managerial framework and illustrate it with examples from the industry

Optimal Prototyping on Experimentation Platforms

Testing and prototyping comprise an integral part of almost any new product development process. Recent emergence of experimentation platforms who specialize in offering evaluation/assessment of prototypes to outside parties have opened up the possibilities for firms in reconfiguring their product development processes. Firms can, by outsourcing the evaluation stage of their dev-test cycles, obtain cost efficiencies and scale. At the same time, a lack of visibility into the actual evaluation process and the possible ambiguity in the product development firm\u27s requirements may lead to potentially noisy evaluations, raising concerns regarding the fidelity and accuracy of the results. The current article formulates a model of “outsourced evaluations” and examines how the noisy low-fidelity evaluations alter the firm\u27s optimal prototyping. Our results demonstrate that imperfect evaluation fidelity changes the client\u27s optimal experimentation, with starkest difference being that it can make it optimal for the client to select and launch a prototype that did not yield the best evaluation. In addition, our analysis reveals that the client should optimally request most precise measurements when their ex-ante uncertainty is moderate (not too high or low). Finally, examining the optimal measurement technology choices of the platform, we find that when the client\u27s ex-ante uncertainty increases from moderate to high values, the platform should offer lower fidelity evaluations, but at a higher fee. We develop managerial insights for how the optimal choice of fidelity and the optimal length of the evaluation cycle should be planned depending on the platform\u27s evaluation fees and the client\u27s ex-ante uncertainty. The resulting framework can offer guidance to product and software development firms who leverage external experimentation platforms

Overcoming Barriers to Customer Co-Design: The Role of Product Lines

A key barrier to companies successfully engaging customers in the design of new products is customers fearing that they will be forced to pay much more for the custom products they help design. This fear is justified by the fact that once the customer has invested significant time and effort in co-designing a product, the firm can extract all the resulting consumer surplus through higher prices. At the same time, the firm allowing its customers to co-design products would be unlikely to commit to a price up front before knowing the complete design of the custom product, since it would then face significant risk of losing money. In this paper, we develop analytical models for this problem, and show how a firm can motivate its customers to engage in co-design. We also show how offering co-design can impact the firm\u27s product (line) strategies and the quality of its products, including motivating the firm to increase the quality of its standard product, sometimes even beyond the efficient quality level. The effect of market and firm characteristics on the value of engaging customers in the co-design process is also examined. In addition, we show that the presence of information asymmetry about the firm\u27s co-design capability may lead to even higher levels of co-design effort by the customer. These results provide valuable insights for managers regarding the potential value of supporting customer co-design.

Implications of Product Lifecycle and Channel Structure upon Optimal Investment in Durability

We explore the interactions between channel structure and mode of operations (leasing versus selling) and their implications for a manufacturer\u27s willingness to invest in making her product more durable. Using a centralized manufacturer who leases her product as a point of reference, we find that an isolated change in either the channel structure (centralized to decentralized), or the operational mode (leasing to selling) can decrease the manufacturer\u27s willingness to provide durability. However, if combined, these two changes together may strengthen the manufacturer\u27s willingness to invest in durability. Consequently, a manufacturer who sells through an intermediary may invest more in durability than one who leases directly to end consumers

Competitive Product Introductions in Technologically Dynamic Environments

New product development in several industries is driven by innovations in underlying technologies. Firms developing new generation products often face the following choice: they can either introduce a product based on a proven and immediately available technology, or delay product introduction to incorporate a superior, yet unproven, technology. In this paper, we study how competing firms introduce new products in such technologically fluid environments. We show that this technology selection decision for new-generation products depends on the evolution of technology trajectories, the additional risk involved in developing advanced versions and the competitive intensity in the end-product market. By staggering their new product introductions over time, firms are able to utilize introduction timing as an additional dimension to distance themselves from their rival. The optimal investment by a firm in product development, and its sensitivity with respect to competition, are also characterized. We also extend our analysis to consider the impact of market factors such as network effects and growth potential on the profitability of different introduction strategies