Product Offerings and Product Line Length Dynamics

60 Pages Posted: 6 Jul 2014 Last revised: 8 Oct 2014

See all articles by Xing Li

Xing Li

Peking University - Guanghua School of Management

Date Written: October 6, 2014

Abstract

This paper provides a model that uses preference heterogeneity to rationalize the cross-sectional and intertemporal variation in a firm's product proliferation strategies. Product-line dynamics arise from shocks to preference heterogeneity. For example, in the potato chip category I study, consumer concerns over fat levels in foods created two desirable alternatives (low fat and zero fat) for each flavor. On the supply side, firms learn about these changing tastes and adapt product lines accordingly. For tractability, the heterogeneity in preference is captured within the nesting parameter in an aggregate nested logit demand model. I find greater preference heterogeneity for smaller packages of chips and for markets with more demographic diversity. The dominant firm in the market bases its decisions primarily on past experience in the market, with the latest preference shocks representing only 30% of the influence in product-line decisions. Gross margins are increased by 5% if firms have perfect information about preference diversity. Costs for product line maintenance constitute about 2% of total revenue. Sunk costs incurred when expanding the product line are estimated to be four times the per-product fixed cost, thereby limiting the flexibility of product-line adjustment. The probability of line length adjustment grows from 70% to 90% under a smooth cost structure.

Keywords: product proliferation; product line; Bayesian learning; numerical dynamic programming; dynamic structural models

JEL Classification: D83; L66; M31

Suggested Citation

Li, Xing, Product Offerings and Product Line Length Dynamics (October 6, 2014). Available at SSRN: https://ssrn.com/abstract=2462577 or http://dx.doi.org/10.2139/ssrn.2462577

Xing Li (Contact Author)

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

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