SSE/EFI Working Paper Series in Economics and Finance 653
Destructive Creation is the deliberate introduction of new, perhaps improved generations of durable goods that destroy, directly or indirectly, the usage value of units previously sold inducing consumers to repeat their purchase. This paper discusses this practice by a single seller in an infinite-horizon, discrete time model with heterogeneous consumers. Despite the lack of commitment power over future prices and introduction policies, this practice restores partially or totally market power even though consumers anticipate opportunistic behavior. However, the monopoly resorts too much to this mechanism from an ex-ante, profit maximizing perspective. High prices in earlier periods allow the seller to commit to defer innovation and therefore to maintain buyers' confidence over durability. The paper characterizes the equilibrium properties of the resulting innovation cycles such as existence, uniqueness and asymptotic stability and discusses potential regulatory remedies in those instances where destructive creation generates economic inefficiencies. This theory applies, among others, to markets characterized by network externalities, compatibility issues, standard setting, social consumption and signal provision and may help explain many restrictive aftermarket practices as well as excessive add-on pricing without relying on any leverage hypothesis.