Quality Investments and Costly Adoption

Abstract In many markets, consumers incur adoption costs when switching from a low-quality good to a high-quality good. We analyze under which circumstances the competing firm has an incentive to invest in high quality. We investigate two scenarios: (i) homogeneous and (ii) heterogeneous adoption costs. If adoption costs are homogeneous, the competing firm produces high-quality goods for sufficiently low adoption costs, and an increase in adoption costs reduces the range of values for which the competing firm invests in high quality. In contrast, if adoption costs are heterogeneous, the competing firm produces high-quality goods for sufficiently high adoption cost heterogeneity, and an increase in average adoption costs expands the range of values for which the competing firm invests in high quality.