Erasmus school of economics product Variety and Innovation
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- Introduction Apple and Samsung
- Horizontal product variety model
- Vertical product variety model
- Additional product variety theories
- Patent thickets and cross licensing
- Discussion / Limitations
Table of contentsTable of contents 2 Introduction 3 Apple and Samsung 3 Patents 3 Product variety 4 Current research 4 Theoretical Framework 6 Horizontal product variety model 6 Vertical product variety model 8 Additional product variety theories 10 Patent thickets and cross licensing 12 Methodology 14 Data 15 Results 17 Conclusion 20 Discussion / Limitations 23 References 25 Appendix 28 IntroductionApple 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. 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?” To answer this question the following hypotheses are stated:
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. 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  which can be rewritten to:  . 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 price p1. Substituting the first expression into the second results in  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  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: More generally when a firm sells n product variants (horizontal differentiation) instead of one the rule becomes: 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” 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: 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: 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 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: If the company only offers one high quality product the price has to be: 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 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)
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.
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%
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. 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 ( 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. ReferencesAcs, Z. J., & Audretsch, D. B. (1989). Patents as a Measure of Innovative Activity. KYKLOS(42), 171-180. Amazon. (2014). Samsung Galaxy S5 SM-G900H 16GB Factory Unlocked International Verison . Retrieved from Amazon: http://www.amazon.com/Samsung-SM-G900H-Factory-Unlocked-International/dp/B00J4TK4B8/ref=sr_1_1?s=wireless&ie=UTF8&qid=1402655934&sr=1-1&keywords=samsung+galaxy+s5 Apple Inc. (2014). Retrieved from Iphone 5s Features: http://www.apple.com/iphone-5s/features/ Bessen, J. (2013). Patent Thickets: Strategic Patenting of Complex Technologies. Boston University. Boldrin, M., & Levine, D. K. (2013). The Case Against Patents. Journal of Economic Perspectives, 3 - 22. Cunningham, A. (2013, June 29). Ars Technica. Retrieved 2014, from Report: Apple to stop using Samsung-made chips beginning in 2014: http://arstechnica.com/apple/2013/06/report-apple-to-stop-using-samsung-made-chips-beginning-in-2014/ Elias, P. (2014, 02 05). Jury: Samsung Infringed Apple Smartphone Patents. Retrieved June 2014, from http://www.huffingtonpost.com/2014/05/02/apple-samsung-apple-patent_n_5256854.html Investopedia. (2014). Monopolistic Competition . Retrieved from http://www.investopedia.com/terms/m/monopolisticmarket.asp Lancaster, K. (1990). The Economics of Product Variety: A Survey. Marketing Science, 189 - 206. Oxford University Press. (n.d.). Retrieved from Oxford Dictionaries: http://www.oxforddictionaries.com/definition/english/patent Pepall, L., Richards, D., & Norman, G. (2014). Product Variety and Quality Under Monopoly. In Industrial Organisation (pp. 142 - 172). John Wiley & Sons, Inc. Pil, F. K., & Holweg, M. (2004). Linking Product Variety to Order-Fulfillment Strategies. Interfaces, 394 - 403. Ramdas, K. (2003). Managing Product Variety: An Integrative Review and Research Directions. Production and operations managment, 79 - 101. Ranger, S. (2014, April 16). Samsung Galaxy S5 costs $256 to build, $50 more than iPhone 5s. Retrieved June 2014, from ZD Net: http://www.zdnet.com/samsung-galaxy-s5-costs-256-to-build-50-more-than-iphone-5s-7000028493/ Reuters, T. (2014, April 9). Samsung, Apple agonise over smartphone profit margins. Retrieved June 2014, from NDTV Gadgets: http://gadgets.ndtv.com/mobiles/features/samsung-apple-agonise-over-smartphone-profit-margins-506145 Samsung. (2014). Samsung Phones. Retrieved from http://www.samsung.com/nl/consumer/mobile-phone/mobile-phones/mobile-phone Shaprio, C. (2001). Navigating the Patent Thicket: Cross Licenses, Patent Pools, and Standard Setting. Innovation Policy and the Economy, 119 - 150. Statista Inc. (2011, August). Number of mobile device patents in the United States in 2011, by leading company. Retrieved from www.statista.com/statistics/275238/mobile-device-patents-by-company/ Statista Inc. (2014). Global market share held by leading smartphone vendors. Retrieved June 2014, from http://www.statista.com/statistics/271496/global-market-share-held-by-smartphone-vendors-since-4th-quarter-2009/ US Patent and Trademark Office. (2014). PatFT Patents. Retrieved from http://patft.uspto.gov/ 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
Search terms used on US Patents and Trademark Office: AN/"Samsung Electronics Co, Ltd" AND APD/20090101->20100101 AN/"Samsung Electronics Co, Ltd" AND APD/20100101->20110101 AN/"Samsung Electronics Co, Ltd" AND APD/20110101->20120101 AN/"Samsung Electronics Co, Ltd" AND APD/20120101->20130101 AN/"Apple Inc" AND APD/20090101->20100101 AN/"Apple Inc" AND APD/20100101->20110101 AN/"Apple Inc" AND APD/20110101->20120101 AN/"Apple Inc" AND APD/20120101->20101301 Entry E:
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this implies that when a firm decides to sell one more product variant the profit will be: 
. Simplification of this formula results in a general rule, the additional product variant increases profit if and only if 
.
. 
is a measure of value that consumer i places on quality. 
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.
. 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: 
. Besides the surplus from buying the high quality product has to be greater or equal to 0: 
. Combining these equations results in a formula for the price of the high quality product: 
. 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 
. Also the prices increase when all consumers value quality more.
consumers of each type and as discussed before costs are independent from quality, the profit function is: 
. From this equation it becomes clear that profit increases in 
, meaning that the company should set the quality of its high quality product as high as possible. For the lower quality product 
it is depending on the second part of the equation.
. The second part of the equation will be positive, resulting in a positive effect of 
the company’s profit decreases in 
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: 
. The low quality good has to be priced: 
. This results in 
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)
of their patents for their mobile phone department. By Samsung around 35% 
of the patents involve mobile technology. These percentages are used to calculate the other years.
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.