The Dark Side of Category Expansion: Will (and Which) Existing Ones 'Pay the Price'?

Abstract

Many retailers that manage product assortments believe that “more is better”. We challenge this conventional wisdom by demonstrating that a retailer may face more price-sensitive demand for existing categories after a category expansion. While introducing a new category to a store may increase the demand for the existing ones, this increase sometimes suggests a movement towards the steeper part of the demand curve and an increase in price sensitivity. We build a model of multi-category purchases with transportation costs and generate a series of theoretical predictions of the changes in price sensitivity after category expansion. We then estimate the model parameters in a natural experiment setting, where a set of Washington retailers’ assortments are exogenously affected by the state’s privatization of liquor sales in 2012. Consistent with the theoretical predictions, the increase in price sensitivity is considerable in two out of the six existing categories. Counterfactual simulations suggest that retailers could have a profit loss as high as 2.2% if the changes in price sensitivity were ignored. This suggests that retailers who don't re-estimate and re-optimize their marketing mix may “pay a price” after category expansion.

Keywords: category expansion, price sensitivity, one-stop shopping, multi-category demand, hierarchical Bayesian methods