Market Expansion or Margin Erosion: The Double-Edged Sword of Digital Convergence

Digital convergence enables firms in the computing, communications, and electronic consumer industries to design and launch multifunctional converged products. This presents firms with a significant opportunity for value creation and profit growth. At the same time, the increased substitutability between products supplied by different industry segments heightens competition and poses a significant threat of margin erosion. These conflicting incentives make it difficult for firms in converging industries to make strategic product line and product design decisions. In our study, we analyze the technological, product, and market factors that have an impact on these decisions and derive conditions under which it is (and is not) optimal for firms to launch converged products that combine the functionalities of products in two different industries. We find that the optimality of including converged products in the product line depends crucially on the synergies arising out of functionality colocation. Further, as technology permits higher levels of product convergence, converged products relegate specialized products to narrow market niches, even when there is some quality degradation from functionality colocation. Overall production and total firm profits tend to increase, although the impact on consumer surplus and total welfare is ambiguous.