Product Variety and Innovation - EUR · Web viewFor example after the introduction of their innovative Galaxy S4, Samsung also introduced a S4 Zoom, S4 Active and S4 Mini. These models

EraSMUS SCHOOL OF ECONOMICS

Product Variety and Innovation

A Comparison of Apple and Samsung

Wessel van Rietschoten

17-7-2014

Abstract: This research compares the amount of patents obtained by Apple and Samsung

with the amount of phones these companies introduce to the market. This data will be

combined with existing theories on horizontal and vertical product variety and patent

thickets to see if the observed data can be explained by existing models. This research

shows that the difference in product variety between the two companies can be explained

using a vertical product variety model. A connection between vertical product variety and

innovation can be found through the design cost of adding lower quality product types.

Companies owning many patents may have to incur less cost in order to design additional

products. However these results are not robust and further research is necessary.

1 Table of contents

Table of contentsTable of contents.........................................................................................................1

Introduction..................................................................................................................2

Apple and Samsung..............................................................................................................2

Patents..................................................................................................................................2

Product variety......................................................................................................................3

Current research...................................................................................................................3

Theoretical Framework................................................................................................5

Horizontal product variety model...........................................................................................5

Vertical product variety model...............................................................................................6

Additional product variety theories........................................................................................8

Patent thickets and cross licensing.....................................................................................10

Methodology..............................................................................................................12

Data...........................................................................................................................13

Results.......................................................................................................................15

Conclusion.................................................................................................................18

Discussion / Limitations.............................................................................................20

References................................................................................................................22

Appendix....................................................................................................................24

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Introduction

Apple and SamsungWith the introduction of Apple’s first iPhone in 2007 a lot has changed on the

smartphone market. A new standard was set for mobile phones and competitors

were facing difficulties meeting these new standards. It lasted until 2009 before

Samsung developed a competing model, the Samsung Galaxy. With the introduction

of the Galaxy series Apple started losing market share to Samsung. This even led to

Samsung taking over a leading position in the market, forcing Apple to be second.

These two giants on the global smartphone market have clashed ever since. (Statista

Inc., 2014)

The success of the Samsung Galaxy was partly due to its similarity with the Apple’s

iPhone. Kristin Huguet, spokeswoman of Apple stated: “Samsung wilfully stole our

ideas and copied our products. We are fighting to defend the hard work that goes into

beloved products like the iPhone, which our employees devote their lives to

designing and delivering for our customers.” Lawsuit after lawsuits led to a patent war

unprecedented in business history. In separate trials in the year 2012 Apple had won

$930 million from Samsung because of patent infringement. However considering the

worldwide Smartphone market with a value of $330 billion Samsung can be seen as

the real winner. In the latest lawsuit at the beginning of 2014 a California jury

awarded Apple less than 10% of the compensation Apple had requested, partly

because also Apple had infringed Samsung’s patents with the creation of the iPhone

4 and 5. (Elias, 2014)

PatentsClearly both Apple and Samsung spend a lot of money and effort on patenting their

new developments. According to the dictionary a patent is: a government authority or

license conferring a right or title for a set period, especially the sole right to exclude

others from making, using, or selling an invention. (Oxford University Press, 2014)

Thus in order to prevent competing companies from copying your inventions patents

are essential. Filing patents contributes to achieve and maintain a competitive

advantage over competing companies.

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The number of patents a company owns gives a good indication of the

innovativeness of this company. Empirical research by Acs and Audretsch support

the validity of patent counts as a measure of innovative activity (Acs & Audretsch,

1989). According to this theory companies with more patents are more innovative.

But does this theory hold for Apple and Samsung and their mobile phones?

Product varietyAlthough their mobile phones might look similar the amount of phones brought to the

market by Samsung and Apple differs significantly. Since the introduction of the

original iPhone by Apple, the company introduces one or two new models a year.

Samsung on the other hand has introduced over twenty phones per year for the last

three years (see appendix entry B and C). This difference is remarkable since both

companies are major players on the same market.

When it comes to product variety a distinction has to be made between horizontal

and vertical product variety. Horizontal product variety is when a firm offers multiple

versions of basically the same product. For example an automobile manufacturer

offering the same car in different colors. The product is the same, but the company is

attracting more customers since some people like blue cars while others might like

red cars. Horizontal differentiation is used by companies to attract customers with

different taste preferences while the price stays the same. Vertical product variety on

the other hand is used to differentiate between the willingness to pay for quality by

customers. In this case the automobile manufacturer will offer a basic car and one

with for example heated seats. Obviously the car with the heated seats is the better

one but some costumers will be willing to pay a premium for this and others won’t.

By using vertical differentiation companies try to reach more customers by offering

them a larger variety of quality for different prices. (Pepall, Richards, & Norman,

2014)

Current researchThe aim of this research is to look for a possible relationship between the

innovativeness of Apple and Samsung’s mobile phones and the amount of product

variety observed. The main research question of this research is:

“Does more innovative activity lead to a larger product variety?”

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To answer this question the following hypotheses are stated:

1) “More patents lead to more innovative activity.”

2) “Innovative activity is reflected in the amount of horizontal product variety.”

3) “Innovative activity is reflected in the amount of vertical product variety.”

This research compares the amount of patents obtained by Apple and Samsung with

the amount of phones these companies introduce to the market. This data will be

combined with existing theories on product variety and patent thickets to see if the

observed data can be explained by existing models. This research shows that the

difference in product variety between Apple and Samsung can be explained using a

vertical product variety model. A connection between product variety and innovation

can be found through the designing cost of adding lower quality product types.

Companies owning many patents may have to incur less cost in order to design

these additional products. However these results are not robust and further research

is necessary.

5 Table of contents

Theoretical FrameworkMost firms sell more than one product in order to appeal to consumers with different

tastes. Apple’s latest iPhone 5S is available in three different colors: gold, silver, and

space gray. (Apple Inc., 2014) Essentially these phones are the same except for the

color. When a firm offers a variety of products in response to different consumer

tastes it is called horizontal product differentiation. The second option a firm has to

differentiate is vertical product differentiation. When a firm responds to differences in

consumer willingness to pay for quality of a product by offering different qualities of

the same product it is called vertical product differentiation. (Pepall, Richards, &

Norman, 2014) With the introduction of the cheaper iPhone 5C Apple started using

vertical product differentiation in 2013. Samsung makes extensive use of both types

of differentiation. Currently offering 21 different Galaxy models in a wide variety of

prices, colors and product features. (Samsung, 2014)

To determine the optimal amount of product differentiation for a company a model

has to be introduced. Since this research is about Samsung and Apple it is

reasonable to assume that a model based on monopolistic competition is in order.

Both companies produce similar but not yet perfectly substitutable products, are profit

maximizers and have a sufficiently large amount of market power, which are

indications of monopolistic competition. (Investopedia, 2014)

Horizontal product variety modelThe basic model assumes that different consumers have different tastes. When a

monopolistic company offers a product, the product will be closer to some peoples

preferences then to others. The company sells its product for a certain price (p1). The

consumers have their own reservation price (V). For any price above the reservation

price the consumer will not buy the product. The price the consumer is facing is the

price set by the company (p1) and additionally the cost of the product being different

from their optimal taste (t). The consumer is indifferent between buying and not

buying when p1+t x1=V which can be rewritten to: x1=V−p1t

. The variable x1

represents the distance between the consumers optimal product and the product

offered on the market. Assuming that N consumers are evenly distributed on the

market, there will be 2x1N consumers willing to buy the product when the firm set

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price p1. Substituting the first expression into the second results in

Q ( p1 ,1 )=2x1N=2Nt

(V−p1) when the firm is selling one variant of the product. The

highest price the firm can charge in order to reach all N consumers is given by

p (N ,1 )=V− t2 which satisfies the buying decision of consumers with tastes farthest

away from the product offered.

Now in order to determine the optimal amount of products the firms cost have to be

added to the equation. Profit (π) of the firm depends on the revenues as stated in the

equation above but also on marginal production cost per unit sold (c) and fixed cost

associated with production (F). Combining this the profit equation of a firm selling one

product variant is: π (N ,1 )=N [ p (N ,1 )−c ]−F=N (V− t2−c)−F .

More generally when a firm sells n product variants (horizontal differentiation) instead

of one the rule becomes: π (N ,n )=N (V− t2n

−c )−nF this implies that when a firm

decides to sell one more product variant the profit will be:

π (N ,n+1 )=N (V− t2(n+1)

−c )−(n+1)F. Simplification of this formula results in a

general rule, the additional product variant increases profit if and only if n (n+1 )< tN2F .

According to the model horizontal product variety n increases when there are many

consumers (N is large) or when the fixed cost for increasing product variety are low

(F is small) or where consumers have strong and distinct tastes regarding products (t

is large). (Pepall, Richards, & Norman, 2014)

Vertical product variety modelWith vertical product differentiation a company tries to target more consumers by

offering different qualities of the same product. Some people are willing to pay a

higher price for premium products, others aren’t. By offering the choice a larger part

of the market can be served. For a profit maximizing monopolist two conditions have

to be satisfied:

1. “For a given choice of quality, the marginal revenue from the last unit sold should

equal the marginal cost of making that unit at that quality”

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2. “For a given choice of quantity, the marginal revenue from increasing quality of

each unit of output should equal the additional (marginal) cost of increasing the

quality of that quantity output.”

When it comes to costs the model assumes that the cost of improving product quality

is a sunk cost, making production cost independent of the quality of the product. The

only cost rising with quality is the cost of designing the product.

By using vertical product variety the company targets to types of consumers. Type 1

consumers place a higher value on quality then type 2 consumers. These two types

of consumers (i) differ in surplus they get from buying the product with quality z at

price p: V i=θ i ( z−zi )−P. θi is a measure of value that consumer i places on quality. z i

is the lower bound quality below which consumer i would not buy the product any

more. Although the company knows of the existence of these types of consumers it

cannot distinguish them.

The idea is that the company brings two product types to the market, a low price low

quality version and a high price high quality one. For consumer type 2 to buy the low

priced product the price has to be low enough for his low valuation of quality: p2=θ2 z2

. Type 1 consumers should buy the higher quality product. In order to make this

happen the consumer surplus type 1 consumers get from buying the high quality

good have to be greater or equal to that what they would have got if they bought the

cheap low quality product: θ1 ( z1−z1 )− p1≥θ1 ( z2−z1 )−p2. Besides the surplus from

buying the high quality product has to be greater or equal to 0: θ1 ( z1−z1 )−p1≥0.

Combining these equations results in a formula for the price of the high quality

product: p1≤θ1 z1−(θ1−θ2 ) z2. This formula states that the maximum price a company

can ask for its high quality product is greater when the difference is greater between

the two type of consumers (θ1−θ2 ). Also the prices increase when all consumers

value quality more.

Now that is established how different qualities of products have to be priced the profit

for the firm can be calculated. Assuming that there are N i consumers of each type

and as discussed before costs are independent from quality, the profit function is:

∏ ¿N 1θ1 z1−(N1θ1−(N 1+N 2)θ2)z2. From this equation it becomes clear that profit

increases in z1, meaning that the company should set the quality of its high quality

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product as high as possible. For the lower quality product z2 it is depending on the

second part of the equation.

In the case that there are less consumers of type 1 buying the high quality product

then consumers of type 1 and 2 buying the low quality product: N1θ1< (N1+N2 )θ2. The

second part of the equation will be positive, resulting in a positive effect of z2 on the

company’s profit. In this case z2 should be equal to z1 meaning that the firm only sells

one, high quality product. When N 1θ1> (N 1+N2 )θ2 the company’s profit decreases in z2

creating an incentive for the firm to offer two different qualities.

If the company only offers one high quality product the price has to be: p¿=θ2 z in

order to sell to both types of consumers. When a company differentiates between

high and low quality the price for the high quality product is given by: p1¿=θ1(z−z1).

The low quality good has to be priced: p2¿=θ2θ1 z1θ1−θ2

. This results in p1¿> p¿> p2

¿ which

means that a company with different qualities can charge a higher price to type 1

consumers but has to charge a lower price to reach type 2 consumers. This means

that offering two quality differentiated products is only profitable when there are

sufficiently many type 1 consumers as compared to type 2. (Pepall, Richards, &

Norman, 2014)

Additional product variety theoriesFor completeness other models on product variety from recent literature have to be

discussed. Managing product variety has become more and more important in recent

literature. Kamalini Ramdas argues in his literature review on product variety that any

organization has to make four key decisions in variety creation: dimension of variety,

product architecture, degree of customization and timing. His framework for a firm’s

variety-related decisions is graphically represented in appendix entry A. Most

interesting is the process of variety creation. The dimension of variety chosen by a

firm must be of value to the customer, and it has to contribute to its competitive

advantage. Besides a firm must use synergies across products to keep the cost of

producing a larger variety of products low. The second decision on product variety is

product architecture. When a firm chooses for a modular architecture it allows for

differentiation in the specific components. On the other hand an integral architecture

may increase product integrity but takes away the option to differentiate on

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components. The third decision faced by the firm is the degree of customization.

Generally the firm has to base its decision on what the market values and the firm’s

own internal and supply chain capabilities. Customization may vary from letting

consumers build their own device (high level of customization) to offering a standard

product with predetermined specifications (low level of customization). Lastly timing is

crucial in the variety creation process. Product life cycles together with product

announcements and introduction dates can be crucial for the success of a product.

(Ramdas, 2003)

Another research by Kevin Lancaster concludes that most product variety models

agree on three points. Firstly that scale economies are a major determinant for

product variety. When scale economies arise production cost of large volumes

decrease, this leads to less product variation. Secondly the perception of the

products by the consumers is important. When consumers perceive different, similar

goods as close to perfect substitutes the amount of product variation decreases. If

these goods are not seen as substitutes product variation increases. Lastly the

higher the level of competition on a market, the more product variety. In a market

with little to no competition there is little or no product variety. (Lancaster, 1990)

An article published in 2004 by Pil and Holweg links product variety to order

fulfillment strategies. This study on automobile industry aimed to find a link between

external variety (variety offered to the consumers) and internal variety (variety

involved in making the product). For many years forecast-driven order fulfillment

strategies were considered to be the best strategy. The production process is driven

by an sales forecast, causing stable capacity and good use of economies of scale.

On the downside it has low flexibility, high inventories and forecast errors might lead

to obsolete inventory. Relatively new is the build to costumer order fulfillment

strategies. This strategy leads to more customized products and lower inventories.

But since it is demand driven capacity use might vary significantly. Currently a hybrid

form of both forecast and order driven systems is observed in many companies.

Crucial for managers is to consider if their current order fulfillment strategy is

sufficient for the products they offer. Some products don’t need customization or can

be adjusted by the costumer himself, for these products forecast-driven systems

might be the best strategy. For products that do need customization order-driven

systems are often more effective. Precursor in build to order strategies is computer

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manufacturer Dell, offering customers the option to select different qualities of

computer parts to build their own customized PC. This extreme form of customization

can grant a competitive advantage which is interesting for other companies who are

developing their product variety strategy. (Pil & Holweg, 2004)

Patent thickets and cross licensing To be able to connect product variety and innovation also literature on innovation and

patents have to be reviewed. As mentioned before patents are an accepted way of

measuring a company’s innovative activity. However the added value of the patent

system itself is up for discussion. A study by Boldrin and Levine advocates the case

against patents. Their study is in favor of abolishing the current patent system since

there is no empirical evidence that patents increase innovation nor productivity.

(Boldrin & Levine, 2013)

If patents are not contributing to more innovation or productivity, why are they

observed and valued so much in real life? The most obvious reason of course is the

protection of its intellectual property by a company. However with complex

technologies one patent doesn’t cover the complete product. Research on patent

thickets by James Bessen gives a possible explanation for the large amount of

patents observed at companies dealing with complex technologies. Patent thickets

are large overlapping sets of patent rights in order to force competitors into cross-

licensing. In his research Bessen explains a model which explains strategic patenting

when a single technology involves a large number of patents. When the costs of

patenting are low, firms will build large portfolios of patents. Since these complex

technologies require a large amount of patents, building a patent thicket serves a

company well. If not they but their competitor achieve a drastic innovation, they will

get part of the rent since their competitor most likely needs to cross-license one or

more of their patents. “Patents serve to subsidize the losers of innovation races (paid

by the winners), especially if those losers are large patent holders in mature

industries.” (Bessen, 2013)

An earlier study on patent thickets acknowledges the same phenomena of firms

having difficulties commercializing their innovations because of patent infringements

caused by patent thickets of competing companies. Under the current system of

strong patent rights, patent thickets are not only used to capture part of the rents of


the drastic innovation from the competitors. They can also be used to increase

transaction cost, create hold up problems and even block innovations of competitors.

These issues make it harder to bring an innovation to the market and gives firms an

incentive to build a large portfolio of patents, to protect themselves against

innovations from other firms. (Shaprio, 2001)


MethodologyIn order to carry out this research data has been collected. A list with Samsung

Galaxy phones and Apple iPhones was composed using data from both companies

websites. This list was used to form an overview on how many phones both

companies have introduced since 2009.

To match the amount of phones introduces per year to the amount of patent filed per

year data has been collected on patents obtained per year using the website of the

United States Patent and Trademark Office. (US Patent and Trademark Office, 2014)

By searching on a yearly interval from 2009 onwards together with the assignee

name of the company (see appendix entry D for the specific search terms used).

The amount of patents obtained by Apple and Samsung per year is companywide, so

this also includes patents from other business activities. Since this research is about

the mobile phone department of both companies the overall number of patents is an

overestimation of the amount of patents obtained by the phone department. In order

to correct for this a data source on the number of mobile device patents in the United

States in 2011, by leading company is used (see appendix entry E). (Statista Inc.,

2011) Comparing the total amount of patents filed in 2011 with the amount of mobile

device patents from the source gives an indication of the percentage of patents the

companies issue for their mobile phone departments. The same percentage will be

used to correct the total amounts of patents in the other years to get a more accurate

estimation of patents obtained for mobile phones per year.

After the data is presented, the theories as explained in the theoretical framework will

be used to explain the observed data. By combining the theories on product variety

and patent strategies with the collected data this research aims to explain the

observed situation at Samsung and Apple.


DataAs described in the methodology data on the amount of phone introductions per year

by Apple and Samsung is gathered. Table 1 shows the amount of phones per year

per company. As can be seen just by looking at the amount of phones introduced

over the last five years there is a big difference in product variety between Apple and

Samsung. Note that every iPhone at introduction data was made available with

different storage capacities. This can be considered a form of product variety but are

left out of this research for simplicity. Because Samsung Galaxy phones provide the

option for an external SD data card, comparing on this feature is challenging.

Year Apple iPhone Samsung Galaxy

2009 1 2

2010 1 6

2011 1 21

2012 1 24

2013 2 29

Total 6 82

Table 1: Introduced phones per company per year.

For the same years the amount of patents obtained by the companies is represented

in Table 2. The amounts of patents corrected for use in mobile devices are based on

data on 2011. In 2011 Apple used approximately 43% (831−477831

≈0.4259) of their

patents for their mobile phone department. By Samsung around 35%

( 2346−15922346

≈0.3482) of the patents involve mobile technology. These percentages

are used to calculate the other years.

Year Apple (Phones) Samsung (Phones)

2009 825 (352*) 3578 (1246*)

2010 1037 (442*) 3120 (1087*)

2011 831 (477) 2346 (1529)

2012 652 (278*) 1345 (468*)

2013 117 (50*) 257 (90*)


Total 3462 (1475*) 10646 (3707*)

Table 2: Patents obtained per company per year. *Corrected amount of patents used

for mobile device as part of total amount of patents using percentage from 2011 data.

Figure 1 is a graphical representation of Table 1 and 2. Combining the amounts of

phones introduced with the amounts of patents obtained per year by Apple and

Samsung in one graph.

2009 2010 2011 2012 20130

200

400

600

800

1000

1200

1400

1600

1800

0

5

10

15

20

25

30

35

Apple Mobile Device Patents Samsung Mobile Device PatensApple iPhones Samsung Galaxy Phones

Year

Mob

ile d

evic

e pa

tent

s

Phon

es In

trodu

ced

Figure 1: Graphical representation of the amounts of patents obtained and phones

introduced by Apple and Samsung per year.

Figure 1 clearly shows two very different product variety strategies. Apple on one

hand introduces very little different phones per year. Samsung on the other has

introduced over twenty types of phones for the last three years. Also the amount of

patents obtained by both companies is differs significantly. Samsung issues more

than double the amount of patents for their mobile devices as Apple for most of the

years.


ResultsFrom the data two big differences between Apple and Samsung are observed.

Samsung introduces a lot more different phones per year and issues more patents.

Following previous literature patents can be seen as a measure of innovative activity,

(Acs & Audretsch, 1989) which means that Samsung has more innovations because

of the larger amount of patents obtained. So the larger amount of products brought to

the market by Samsung might be explained because their innovative activity is larger.

However this reasoning assumes that the products introduced by Samsung are all

innovations. By looking at the list of phones introduced by Samsung (see appendix

entry B) can be seen that this assumption might be incorrect. Samsung Galaxy S

phones are considered their most innovative models. For example after the

introduction of their innovative Galaxy S4, Samsung also introduced a S4 Zoom, S4

Active and S4 Mini. These models are modifications of the original S4, no pure

innovations.

Product variety strategies might explain the larger amount of phones introduced by

Samsung. According to the horizontal product variety model the market size, fixed

cost of making additional product types and the distribution of tastes on the market

determine the optimal strategy for a firm. Since Apple and Samsung serve the same

global market it is reasonable to assume that market size is the same for both firms.

The same logic applies for the taste distribution on the market, if they serve the same

market this will also be equal. So the difference in product variety has to be explained

by a difference in fixed cost of making additional products types.

For simplicity we assume the production process of Apple and Samsung to be

similar. Which is a sound assumption since they develop similar products in similar

production countries. Apple even used parts produced by Samsung in their iPhones

for a long time, making the production process for some parts even identical.

(Cunningham, 2013) Interestingly the variable manufacturing costs of the parts of a

Samsung Galaxy S5 are $256 which is $50 higher than those for an iPhone 5s.

However this only displays the cost of manufacturing the phone parts. Software,

licensing and royalty payments are not included. (Ranger, 2014) When it comes to

retail price Apple’s iPhone 5s is most expensive, $649. (Apple Inc., 2014) Samsung’s


Galaxy S5 has a retail price of only $592 (Amazon, 2014). A phone that is cheaper to

make and is selling at a higher price, does Apple simply has a higher profit margin or

do they incur more cost in licensing and royalty payments?

Apple’s profit margin indeed is a lot higher than Samsung’s, with a margin of 40%

Apple’s profit per iPhone 5s sold is $260. Samsung only has a 16% profit margin per

Galaxy phone sold, for the S5 this means $95 per phone. (Reuters, 2014)

Straightforward calculations show that for a iPhone 5s after deducting manufacturing

cost and profit margin $649 – $206 – $260 = $183 is left unaccounted for. The same

calculations for the Galaxy S5 show $592 – $256 – $95 = $241 of costs that are not

yet explained.

These remaining fixed cost can amongst others be explained by the costs a firm has

to incur in (cross-)licensing patents. Intuitively it is reasonable that these costs are

higher for Samsung than for Apple. Samsung issues a lot more patents and besides

has to pay large amounts in patent infringements lawsuits. The reason for Samsung

to issue a lot of patents can be explained with the theory on patent thickets.

Samsung protecting itself from drastic innovations by competitors by trying to gain a

part of the rent by forcing that competitor to cross-license their patents. With success,

as mentioned before Apple had to settle their lawsuit because they infringed

Samsung’s patents in the creation of the iPhone 4 and 5.

According to the model on horizontal product variety higher fixed costs involved with

additional product types leads to lower product variety. Following this reasoning

Samsung should have less product variety because they incur more fixed costs on

licensing, which is not in line with the data observed.

In the vertical product variety model the difference between the products offered is in

quality and price. As mentioned before Samsung offers one high quality model and

for every of these there are 2 or more lower budget models. Assuming that Samsung

uses vertical product variety because it offers different qualities of products for

different prices is more in line with the data observed. In order to explain why

Samsung chooses to do this and Apple does not, the model offers two options. When

it comes to costs the vertical product variety model assumes all costs sunk, meaning

they should not matter to the decision making. The only cost that does influence the

decision making is the designing cost of the additional quality product. A second


explanation given by the model is the amount of type 1 and type 2 consumers. When

there are fewer type 1 consumers buying the high quality good than type 1 and 2

consumers buying the lower quality (N1θ1< (N1+N2 )θ2) the company cannot profit from

offering different qualities. This might explain why Apple only sells one high quality

product, however it does not explain why Samsung does offer different qualities.

Assumed is that Apple and Samsung do serve the same market and the same

consumers. This assumption implies that N1∧N2 are the same for both companies,

which should mean that they both should get to the same optimum of vertical product

variety. Another issue with the vertical product variety model is the price. Samsung

offers high and lower quality products which according to the model should mean that

their high quality product is higher priced than when offering just one quality. This is

not observed in the data, Apple although they only offer one high quality product

charges the highest price.

Another more obvious explanation for the observed difference in product variety at

Apple and Samsung is the difference in profit margin on their phones. Because

iPhones have a high profit margin Apple doesn’t have to sell as many phones to

make a large profit. Samsung on the other hand has lower profit margins on their

phones, in order to be profitable for the company they thus have to sell a lot of

phones. By introducing more types of phones with slightly different features and price

categories Samsung succeeds in expanding their sales and generating more

revenue.


ConclusionThe main research question in this paper was: “Does more innovative activity lead to

a larger product variety?” After analyzing data on Samsung and Apple together with

theories on product variety and patent thickets the conclusion can be drawn that the

research question cannot be confirmed.

The first hypothesis stated that “more patents lead to more innovative activity”.

Although some literature suggests that patents do accurately reflect a company’s

innovative actives, in the case of Apple and Samsung this does not hold. The data

has shown that Samsung owns and issues a lot more patents per year than Apple.

However since the introduction of the iPhone and the first Galaxy there hasn’t been

any more drastic innovation coming from either of the two firms, indicating that all

these patent do not lead to innovations per se. A more reasonable explanation for the

large amount of patents hold by Samsung comes from the theory on patent thickets.

The desire of firms to hold large amount of patents, is a form of protecting from

innovation by competitors. By forcing competitors to cross-license when they are

trying to commercialize an innovation, a company can capture part of the rents

coming from this innovation.

The second hypothesis was: “Innovative activity is reflected in the amount of

horizontal product variety.” Because the first hypothesis could not be confirmed, it is

hard to prove or disprove this statement with the available data. Horizontal product

variety models suggest that the amount of product variety depends on the market

size, fixed cost of making additional product types and the distribution of tastes. The

market size and taste distribution is assumed equal since both companies serve the

global mobile telecom market. So the link between innovative activity and product

variety should be found in the fixed cost of making additional product types. Theory

predicts that higher fixed costs leads to less horizontal product variety. Higher fixed

costs and more product variety for Samsung contradict this horizontal product variety

model. Based on this can be concluded that the difference observed between

Samsung and Apple cannot be explained with the use of horizontal product variety

models.


The last hypothesis was: “Innovative activity is reflected in the amount of vertical

product variety.” The data has shown that Samsung does use vertical product variety

because they offer different quality products for different prices. Apple only offers one

high quality product. However if this difference can be explained by innovative activity

as the hypothesis suggest is doubtful. The model assumes all cost to be sunk when

evaluating the use of vertical product variety. The only cost that has to be considered

is the designing cost of the additional quality product. It could be that these cost for

Samsung are lower since they own a lot more patents. Because of their large patent

ticket it might be less costly for Samsung to design a new product because they can

use one of the patents they already own instead of buying or developing a new one.

Another explanation offered by the model is a difference in type 1 and 2 consumers

for both companies. When relaxing the assumption of both companies serving

exactly the same market and consumers this is a reasonable explanation for the

observed difference in product variety between the two companies. However this

explanation does not provide a connection with innovative activity.

Getting back to the main research question, larger product variety is not just caused

by more innovative activity. This research shows that Samsung and Apple have very

different product variety strategies. Samsung has a lot of vertical product variety in

their mobile phone department, Apple very little. The most logical explanation for this

is the profit margins both companies have on their phones. Since Apple targets the

premium market and gets high profit margins, they have no incentive to introduce

other lower priced models. These might even negatively affect their high end

reputation. Samsung on the other hand has lower profit margins, meaning they have

to sell more devices to reach the same profit levels as Apple. By introducing a large

variety of phones, Samsung aims to satisfy a larger part of the market in order to sell

more phones. This explains most of the difference in product variety between the two

companies.

The only link this paper shows between innovative activity in the amount of patents a

company has and its product variety is through the designing cost of adding lower

quality and lower priced products. When a company owns a lot of patents, less cost

might have to be incurred to design an additional product quality. However this

explains the data observed, no hard evidence is found. Besides the amount of


patents a company issues has become more of a strategy because of patent thickets

rather than it represents innovative activity.


Discussion / LimitationsTrying to explain phenomena observed in real life with theoretical models is always a

challenging task. Assumptions have to be made in order to fit the model into the data.

The first assumption made in this research was about the quantity of patents

obtained by a firm as a reflector of innovative activity. Although there is literature to

support this assumption (Acs & Audretsch, 1989), this is somehow outdated and can

be challenged. Since Apple and Samsung develop complicated high tech products, it

is more reasonable to assume that the theories on patent thickets apply to these

companies. Following these theories as explained before, patenting can be more of a

strategic move rather than that it reflects innovative activity. Though this takes away

of the validity of current research, it does present an interesting field for further

research.

The second assumption made in this research is about the model on both horizontal

and vertical product variety. The model shows that product variety is determined by

market size, fixed costs of developing additional products and the distribution of

tastes on the market. Current research assumes market size and taste distribution on

the market to be the same for both Apple and Samsung since they both sell to the

same global market. This assumption is reasonable but target markets are not

considered. Apple deliberately choses to only serve the upper end of the market, with

high quality and high priced product. Samsung aims to target a larger part of the

market by making one high and model and some lower priced models, with slightly

different features. So the total market might be the same for both companies, Apple

strategically made a choice to serve a smaller part of this market. This is not reflected

in the model as used in current research although it can explain the product variety

observed. However questions could be raised as why Apple does not offer even

more higher priced, high end models of their iPhones. This could be a way for them

to target a larger part of the market without losing their premium status. Instead they

introduced a budget model last year, which is still priced high compared with

Samsung phones. Further research on the marketing strategies of Apple and

Samsung is needed to shed more light on this topic.


Another drawback of this research is the lack of real evidence on the main result. A

relation between the amount of patents held by a firm and the designing cost of

producing lower quality product types is argued. This seems reasonably within the

assumptions of this research. But this research is about just two companies, making

it difficult to generalize this result. Besides there is no evidence on the magnitude and

strength of this relation. It is questionable if this relation will hold when the

assumptions of this research are released. To see if this relation is valid additional

research has to be done, including more companies. Also omitted variables have to

be considered, as it might be that the observed relation is caused by other factors.

Since there is little known about this topic, more research might reveal valuable

insights. Making this an interesting field of study for further research.

The biggest limitation of this research is the amount of company data and information

available on Apple and Samsung. For obvious reasons both companies are not

providing much data and information on their strategies. An improvement for this

research would be to get an insight within both companies. To know about their

strategic decisions regarding licensing and product variety. With this information the

validity of this research would increase since less or no assumptions have to be

made. Most interestingly would be to know whether or not Samsung and Apple

include the amount of patents hold by their company in their decision making on

product variety.


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AppendixEntry A:

Entry B:

List of Samsung Galaxy Series with introduction dates:

June 2009 - Galaxy

November 2009 - Galaxy Spica

July 2010 - Galaxy 3

Augustus 2010 - Galaxy 5, Galaxy U

October 2010 - Galaxy 551, Galaxy K


February 2011 - Galaxy Ace, Galaxy Fit, Galaxy SL

March 2011 – Galaxy Gio, Galaxy Mini

April 2011 – Galaxy Prevail, Galaxy Pro, Galaxy Neo

May 2011 – Galaxy SII

Jun 2011 – Exhibit 4G, Galaxy Z

Aug 2011 – Galaxy S Plus, Galaxy R, Galaxy W, Galaxy M, Galaxy Y, Galaxy

Precedent, Galaxy XCover

October 2011 - Galaxy Note, Galaxy Stratosphere

November 2011 – Galaxy Nexus

January 2012 – Galaxy Y Pro Duos, Galaxy Ace Plus

February 2012 – Galaxy Ace 2, Galaxy Mini 2, Galaxy Y DUOS, Galaxy Beam

March 2012 – Galaxy Rugby Smart, Galaxy Pocket

April 2012 – Galaxy Rugby, Galaxy S Advance

May 2012 – Galaxy SIII, Galaxy Appeal, Galaxy Ch@t

July 2012 – Galaxy Stellar

Augustus 2012 – Galaxy S Duos

September 2012 – Galaxy Pocket Duos, Galaxy Victory 4G LTE, Galaxy Reverb,

Galaxy Note II, Galaxy S Relay 4 G, Galaxy Rush

October 2012 – Galaxy Express, Galaxy Rugby Pro

November 2012 – Galaxy S III Mini

January 2013 – Galaxy Pocket Plus, Galaxy S II Plus, Galaxy Grand

March 2013 – Galaxy Young, XCover 2

April 2013 – Galaxy S4, Galaxy Frame, Galaxy Mega

May 2013 – Galaxy Win, Galaxy Y Plus, Galaxy Core, Galaxy Star


June 2013 – Galaxy Pocket Neo, Galaxy S4 Zoom, Galaxy S4 Active, Galaxy S4 Mini

September 2013 – Galaxy Note 3

October 2013 – Galaxy Ace 3, Galaxy Core Plus, Galaxy Light, Galaxy Trend Lite,

Galaxy Round, Galaxy Express 2, Galaxy Star Pro

November 2013 – Galaxy Grand 2

December 2013 - Galaxy Trend Plus, Galaxy S Duos 2, Galaxy J, Galaxy Win Pro

January 2014 – Galaxy Grand Neo, Galaxy Note 3 Neo

April 2014 – Galaxy S5

Entry C:

List of Apple IPhones with introduction dates:

29 June 2007 – IPhone

11 July 2008 – IPhone 3G

19 June 2009 – IPhone 3GS

24 July 2010 – IPhone 4

14 October 2011 – IPhone 4S

21 September 2012 – IPhone 5

20 September 2013 – IPhone 5S and IPhone 5C

Entry D:

Search terms used on US Patents and Trademark Office:

AN/"Samsung Electronics Co, Ltd" AND APD/20090101->20100101





AN/"Apple Inc" AND APD/20090101->20100101




Entry E:

Mobile device patents in 2011, by leading company

Number of mobile device patents in the United States in 2011, by leading

company

Number of mobile device patents

values

RIM 3134.00

Nokia 2655.00

Microsoft 2594.00

Qualcomm 2593.00

ATT 1867.00

Samsung 1529.00

IBM 1073.00

Sony 1055.00

Motorola Solutions 1019.00

HP 892.00

Intel 806.00

Motorola-Mobility 706.00

Alcatel-Lucent 680.00

Yahoo 665.00

Broadcom 513.00

Apple 477.00

Cisco 452.00

Ericsson 415.00

Verizon 353.00

Google 317.00

Documents

Product Variety and Innovation - EUR · Web viewFor example after the introduction of their innovative Galaxy S4, Samsung also introduced a S4 Zoom, S4 Active and S4 Mini. These models