This paper challenges the assumption commonly used in the theoretical literature
on customization that consumers always get their ideal varieties when they purchase a customized product. The author adopts Hotelling's horizontal differentiation model with two firms competing for a continuum of consumers. Each consumer has a most preferred variety and possesses a certain level of category-specific knowledge.
Initially, the firms produce standard products located at the end points of the variety interval. Suppose one of the firms offers customization. Consumers familiar
with the brand can easily transfer their needs into appropriate characteristics of
this brand. Consumers unfamiliar with the brand have difficulty in expressing their
preferences. Category-specific knowledge is crucial here. Knowledgeable consumers
are more capable of analyzing information than less knowledgeable ones, and the
products they design better match their preferences. The game runs as follows.
First, the firms simultaneously decide whether to offer customization, then engage
in price competition. The author shows 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
