Intrafirm integration versus separation in product and digital service competition

Digital servitization increasingly requires manufacturing firms to coordinate product and digital service decisions. We develop a duopoly model in which each firm chooses between integration, where product and digital service decisions are jointly coordinated, and separation, where the manufacturing and digital service units make these decisions independently. We characterise equilibrium digital service levels, prices, demand, profits, and organisational choices under symmetric and asymmetric structures. Integration yields higher digital service levels and greater demand than separation when both firms adopt the same structure, while the price ranking reverses as digital research and development (R&D) cost increases. Separation can generate higher profits when competition is sufficiently intense and also under relatively weak competition when digital R&D cost is low; integration becomes more profitable under relatively weak competition when digital R&D cost is high. Profitability also depends on the rival's organisational structure, making firms' choices strategically interdependent. Integration by both firms can constitute a Nash equilibrium even when both would earn higher profits under separation, giving rise to a prisoner's dilemma. Extensions with heterogeneous digital R&D cost coefficients and strategic transfer pricing show that this equilibrium tension can persist.