Technology Adoption in a Declining Market

Rapid technological developments are inducing the shift in consumer demand from existing products towards new alternatives. When operating in a declining market, the profitability of incumbent firms is largely dependent on the ability to correctly time the introduction of product innovations. This paper contributes to the existing literature on technology adoption by considering the optimal innovation investment in the context of the declining market. We study the problem of a firm that has an option to undertake the innovation investment and thereby either to add a new product to its portfolio (add strategy) or to replace the established product by the new one (replace strategy). We are able to quantify the value of the option to adopt a new technology, as well as the optimal timing to exercise it. We find that it can be optimal for the firm to innovate not only because of the significant technological improvement, but also due to demand saturation. In the latter case profits of the established product
may become so low that the firm will adopt a new technology even if the newest available innovation has not improved for some time. This way, our approach allows to explicitly account for the effect of a decline in the established market on technology adoption. Furthermore, we find that under certain conditions an inaction region exists, in which the firm does not innovate, while for lower technology levels it applies the add strategy and for higher technology levels the replace strategy.