Two-Dimensional Product Differentiation Under Duopoly: An Application to Product and Service Reliability

Under oligopoly firms are often observed to specialise their production,
with some firms producing highly reliable output and offering good warranty deals, while others produce less reliable output and offer less attractive warranties, but charge a lower price. This paper develops an approach to product/service reliability which provides an alternative to the conventional analysis based on the characteristics approach. The model of this paper defines reliability as the objective probability of product failure, not as a characteristic of individual goods. Reliability, thus defined, is treated as a choice variable of the firm, and consumers’ preferences are partially endogenised. This approach to reliability is incorporated into a duopoly model which explains the phenomenon of specialisation described above. The model is applicable to the markets for consumer durables, some intermediate goods and some services.