Multi-Product Quality Competition: Impact of Resource Constraints

W e study a multi-product firm with limited capacity where the products are vertically (quality) differentiated andthe customer base is heterogeneous in their valuation of quality. While the demand structure creates opportunities through proliferation, the firm should avoid cannibalization between its own products. Moreover, the oligopolistic market structure puts competitive pressure and limits the firm’s market share. On the other hand, the firm has limited resources that cause a supply-side fight for adequate and profitable production. We explicitly characterize the conditions where each force dominates. Our focus is on understanding how capacity constraints and competition affect a firm’s product-mix decisions. We find that considering capacity constraints could significantly change traditional insights (that ignore capacity) related to product-line design and the role of competition therein. In particular, we show that when the resources are limited, the firm should offer only the product that has the highest margin per unit capacity. We find that this product could be the diametrically opposite product suggested by the existing literature. In addition, we show that for intermediate capacity levels, whereas the margin per unit capacity effect dominates in a less competitive market, proliferation and cannibalization effects dominate in a more competitive market