Integrating Efforts for Product Development and Market Penetration

Technical Report, pp.1-30, 2024

In this paper, we build a decision model to explore an innovative firm’s budget allocation problem,

which needs to be solved for each successive generation of a product. The firm introduces the

product to the market through a distributor while aiming to maximize the market potential. This

goal can be achieved by investing in R&D and increasing availability using subsidies registered

to the distributor. We analyze the problem using bi-level programming and provide a guideline

for the funding strategy. We show that the optimal budget allocation decision is characterized

by two budget thresholds and a threshold on the cost efficiency of R&D. We identify and analyze

the effects of two significant parameters, total available budget and efficiency level of R&D, on

the optimal solution. In addition, we assess the model’s applicability by examining the expected

excess budget requirement and the distributor’s expected profit. We provide valuable managerial

insights on when and how to prioritize the two components of the budget.