An Economic Analysis of Customer Co-design

A key barrier to companies successfully engaging customers in the design of new products is customers fearing that they will be forced to pay much more for the custom products they help design. This fear is justified by the fact that once the customer has invested significant time and effort in co-designing a product, the firm can extract the entire consumer surplus through higher prices. At the same time, the firm allowing its customers to co-design products would be unlikely to commit to a price up front before knowing the complete design of the custom product, since it would then face a significant risk of losing money. In this paper, we develop analytical models for this problem, and show how a firm can motivate its customers to engage in co-design. We also show how offering co-design can impact the firm’s product (line) strategies and the quality of its products, including motivating the firm to increase the quality of its standard product, sometimes even beyond the efficient quality level. The effect of market and firm characteristics on the value of engaging customers in the co-design process is also examined. In addition, we analyze the effects of (a) information asymmetry about the firm’s co-design capability, and (b) competition, on the firm’s decisions regarding co-design. These results provide valuable insights for managers considering investment in technology to support customer co-design. The online appendix is available at https://doi.org/10.1287/isre.2017.0729 .