IPASJ International Journal of Management (IIJM)

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ISSN 2321-645X

A Publisher for Research Motivation........

Volume 3, Issue 9, September 2015

Market switching strategy in a stochastic

business environment: from an early market to
a mature market
Yasunori Fujita
Keio University 2-15-45 Mita Minato-ku Tokyo, Japan

ABSTRACT
In the present paper, by making use of optimal stopping theory, we construct a stochastic dynamic model to derive the optimal
market switching strategy. Main results of this paper are: the producer should switch the market while the profits in the early
market are high if (1) gulf between the early market and the mature market is not deep, (2) market as a whole is not uncertain
or (3) product is vulnerable to other producers introductions of new products.

Keywords: optimal stopping theory, market switching, early market, mature market

1. INTRODUCTION
Owing to demand uncertainty, numerous problems arise with respect to production planning, production system
management, timely distribution and so on. Although new systems such as Quick Response (QR) Systems, Point of Sale
(POS) systems, Management Information Systems (MIS) etc., have been implemented, it is still difficult for producers
to meet the needs of various customers. Especially, as Parik and Ghandhi (2015) point out, since customers these days
build a hierarchy of priorities about expenditure and consumption, companies that have made new product should be
careful in switching markets, i.e., from an early market with a number of visionary customers to a mature one with a
huge block of customers whose orientation is pragmatic.
The present study is an attempt to investigate the way to cross the gulf between these two markets so the new product
might not become a failure. More precisely, the present study determines the optimal timing for the producer to switch
to a mature market from an early market by laying out a stochastic dynamic model based on the optimal stopping
theory, which emphasizes the importance of flexibility and has been used to develop strategies in various stochastically
fluctuating markets. McDonald and Siegel (1986) demonstrate that firms should wait and see until uncertainty is
resolved. Dixit (1989) examine the strategies of a firm that intends to enter a foreign market. Farzin, Huisman and Kort
(1988) investigate the timing of IT investment. Bentolila and Bertola (1990) consider the management of employment
and lay-off. Leahy (1993), Caballero and Pindyck (1996) and Baldursson and Karatzas (1997) analyze the effect of
stochastic fluctuations on the economy. Fujita (2007, 2008) develop optimal stochastic strategies for a fashion retailer
who is a market leader.
Structure of this paper is as follows. Section 2 lays out the basic model and Section 3 describes producers objective
function in a stochastic market. Based on these definitions, Section 4 determines the optimal market switching strategy
and examines its properties. Concluding remarks are made in Section 5.

2. BASIC MODEL
Let us consider a producer who has launched a brand new product in an early market and considers when to switch to a
mature market, in a stochastic business environment where time passes continuously and importance of the future
diminishes with time, which we capture by the discount rate .
Let us assume that profit from the product at t, R(t), follows the geometric Brownian motion of equation (1).

(1)
with initial value R0.
First of all, and are mean and standard deviation of the profits, which we interpret as profitability and market
uncertainty, respectively; larger means that the profitability decreases more quickly and larger means that the
market as a whole is more uncertain. dz is Wiener process that expresses random movement, which has several realworld applications. Often quoted examples are stock market fluctuations, exchange rate fluctuations and so on. It is
often mathematical convenience rather than the accuracy of the models that motivates their use. Recently, Wiener
process has been used to formulate firms revenues (See Dixit and Pindyck (1994) for example). dq, on the other hand,

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IPASJ International Journal of Management (IIJM)

Web Site: http://www.ipasj.org/IIJM/IIJM.htm
Email: editoriijm@ipasj.org
ISSN 2321-645X

A Publisher for Research Motivation........

Volume 3, Issue 9, September 2015

is Poisson process, where R(t) falls by a fixed percentage (with 0<<1) if other producers succeed in developing new
items. We interpret as degree of vulnerability to new products; larger means that the product is more vulnerable to
other producers introduction of new products. In the following, we let (with 0<<1) denote the probability other
producers succeed in developing new products.
Lastly, as for the relationship between the early market and the mature one, we assume that at the moment of switch to
the mature market from the early market, the initial profit in the mature market becomes vR*+S, where v is a positive
constant that express the deepness of the gulf between the early market and the mature market, i.e., smaller v means
deeper gulf, while S is a positive constant that expresses the initial profit in the mature market when the gulf is so deep
that the early market has no positive effect on the mature market.
Since the model of the present paper is stochastic, optimal timing is expressed by cut-off values of revenues, not by the
exact time points. To be precise, we assume that the producer switches to the mature market if the profit in the early
market decreases to R*. In what follows, we derive the optimal values of R* assuming the producers objective is
maximization of sum of the net present value of profits.

3. DESCRIPTION OF THE OBJECTIVE FUNCTION

This section describes the objective function of the producer.
Since the market we consider is stochastic, situation is more complicated than for a deterministic one, and the solution
is derived following the standard procedure for the optimal stopping problem. (e.g.Dixit and Pindyck (1994)).
First of all, expected value of one unit of profit at T, when the producer switches the markets, evaluated at period 0 (i.e.,
the expected value of e

evaluated at period 0) is derived as

G(R0)= (

R*
).
R0

(2)

where is the positive solution to the simultaneous equations F(x)=

2x(x-1)-x and f(x)=(+) -(1-)x as in Figure1

i.e., the positive solution to the characteristic equation

2x(x-1) -x - (+)+(1-)x =0.

Figure 1

Determination of

By making use of (2), we have sum of the discounted profits in the early market E(R*) and the mature market M(R*),
respectively, as

1
R*
{F (
) R*};

R0
R* 1
M(R*)=(
)
(vR*+S).
R0
E(R*)=

(3)

(4)

Thus, sum of the net present value of the profits is expressed as

V(R*)=

1
R*
R* 1
{F (
) R*}+(
)
(vR*+S).

R0
R0

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(5)

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IPASJ International Journal of Management (IIJM)

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ISSN 2321-645X

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Volume 3, Issue 9, September 2015

4. DETERMINATION OF THE OPTIMAL STRATEGY

Now we can determine the producers optimal market switching strategy, that is, the optimal cut-off values of the
profit, R*B, by calculating

dV
0 and solving it with respect to R* as
dR *
S
R *B
.
1 1 v

(6)

With this, the model closes, which enables us to examine the effects of increases in exogenous variables on R*B.
To begin with, from (6) it is clear that increase in v increases R*. (It is assumed here that v satisfies 0 v<1) Since
larger v means shallower gulf, we have
Proposition 1 If the gulf between the early market and the mature market is not deep, the producer should switch
the market while the profits in the early market are high.

~
As Figure 2 shows, increase in shifts F(x) inward to F ( x ) , to decrease to , which brings about decrease in
in
1
B
(6), and hence, decrease in R* . Since larger means that the market as a whole is more uncertain, we obtain
Proposition 2 If the market as a whole is uncertain, the producer should wait to switch to the mature market.
Proposition 2 means that if the market as a whole is uncertain, the producer should stick to the early market.

Figure 2

Effect of an increase in on
~

Similarly, as Figure 3 shows, increase in shifts f(x) upward to f ( x ) , to increase to , which causes increase

in
in (6), and hence, increase in R*B. Since larger means that the producer is more vulnerable to other
1
producers introductions of new items, we have
Proposition 3If the product is vulnerable to other producers introductions of new products, the producer should
switch to the mature market while the profits in the early market are high.
Proposition 3 implies that if the product is vulnerable to other producers introductions of new products, the producer
should not stick to the early market.

Figure 3

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Effect of an increase in on

Page 6

IPASJ International Journal of Management (IIJM)

A Publisher for Research Motivation........

Volume 3, Issue 9, September 2015

Web Site: http://www.ipasj.org/IIJM/IIJM.htm

Email: editoriijm@ipasj.org
ISSN 2321-645X

5. CONCLUDING REMARKS
In the present paper, by utilizing optimal stopping theory, we outlined a stochastic dynamic model to derive the optimal
market switching strategy. Main results of this paper are: the producer should switch the market while the profits in the
early market are high if (1) the gulf between the early market and the mature market is not deep, (2) the market as a
whole is not uncertain or (3) the product is vulnerable to other producers introductions of new products.
It is necessary to examine the robustness of our results in a more general setting. We will take up such analysis next.

References
[1] Baldursson, F. and Karatzas, I. (1997) Irreversible investment and industry equilibrium, Finance and Stochastics 1,
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[2] Bentolila, S. and Bertola, G. (1990) Firing costs and labor demand: How bad is Eurosclerosis, Review of Economic
Studies, 57(3), 381-402.
[3] Caballero, R. and Pindyck, R. (1996) Uncertainty, investment, and industry evolution, International Economic
Review, 37(3), 641-662.
[4] Dixit, A.K, (1989) Hysteresis, import penetration, and exchange rate pass through, Quarterly Journal of
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[5] Dixit, A.K. and Pindyck, R.S.(1994) Investment Under Uncertainty. Princeton University Press, Princeton, New
Jersey.
[6] Farzin, Y.H., Huisman, K.J.M and Kort,P.M. (1988) Optimal timing of technology adoption, Journal of Economic
Dynamics and Control, 22, 779-799.
[7] Fujita, Y.(2007) A New Analytical Framework of Agile Supply Chain Strategies, International Journal of Agile
Systems and Management, ,Vol. 2, No. 4, 345- 359
[8] Fujita, Y. (2008) A new Look at Fashion Brand Management-product switching strategies in the face of imitation,
Research Journal of Textile and Apparel. Vol. 12 No. 3, 38-46.
[9] Leahy, J.V.(1993) Investment in competitive equilibrium: the optimality of myopic behavior, Quarterly Journal of
Economics, 108(4), 11051133.
[10] McDonald, R. and Siegel, D.(1986) The Value of Waiting to Invest, The Quarterly Journal of Economics, 101,
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[11] Parik,S and Ghandhi, S. (2015) Pre Requirement for to sell new product in the market with high impact,
International Journal of Management, Vol. 3 Issue 3, 23-26.

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