The co-evolution of market structure and product architecture

Industries vary substantially in their evolutionary patterns of market structure and of product architectures. Differences exist in the timing, duration, and severity of the shakeout, and the extent to which architectures evolve towards greater modularity. Existing explanations typically treat these phenomena separately, despite recognizing demand heterogeneity as an important factor in both domains. We develop an evolutionary model that links demand heterogeneity with market and architectural evolution by combining characteristics-based demand with the generalized model of NK landscapes. In our framework, consumer preferences are modeled as weight distributions over product characteristics, while firms compete by searching for better designs through component and architectural innovations. Our results show that the structures of, and changes in, demand heterogeneity jointly shape market structures and product architectures. Under stable preferences, demand shapes market selection, reallocates resources across firms, and constrains the set of viable innovation trajectories. Changing preferences induce path-dependent industry dynamics, affecting the intensity of the shakeout and the speed of architectural change. These findings provide a unified explanation for industry differences in market structure and product architecture, and highlight the central role of demand in shaping both industry lifecycles and technological evolution.