Managing product variety in a supply chain

Renato De Matta; Lifang Wu; Timothy Lowe

In recent years, we have seen a rapid continuous growth in the number of stock keeping units of nearly every consumer good category. Firms respond to the diverse taste and continuously changing needs and wants of consumers by increasing their product offerings with the hope of capturing a larger market share and improving profits. Yet strategically some firms would use product differentiation as a competitive weapon to deter potential market entrants. Managing the production and marketing of differentiated products in a supply chain presents many challenges. A firm must determine: (a) the number of product varieties in a product line; (b) the quality of every individual product; (c) the product wholesale and retail prices and (d) an optimal scheme to coordinate the product variety and pricing decisions in the supply chain. Consider a firm with a centralized supply chain network that consists of a manufacturer (denoted by m) and a retailer (denoted by r). Define a product line as a set of products which are differentiated by quality and price. Without loss of generality, we consider a consumer product with a single measurable quality attribute such that having a larger value of this attribute is more desirable. For example, a digital camera with 5 megapixels (MP) is preferred over 3 MP and 2 MP models, m designs and produces a single product line of durable products. Among m's differentiated products, r selects and prices a product assortment and makes them available to heterogeneous consumers. We assume that consumers purchase products from r sequentially and the time between customer arrivals varies at random. Further, the consumer demand is independent of product variety. We also assume that every consumer purchases the utility (consumer surplus) maximizing product. Finally, the consumer makes no purchases if the consumer surplus on every product is nonpositive. We formulate an analytic model to study the intricate relationships among the product variety, product design and product pricing decisions in the centralized supply chain described above. Using classical optimization theory, we find the global optimal solution to our model. Our results show that there always exists a unique profit maximizing number of product varieties. The optimal product line design and pricing strategies are insensitive to changes in consumer valuation. Further, our study also reveals that the optimal solution is insensitive to changes in the market size. Finally, we found that if the product development lead time is relatively long compared to the product's shelf life, a sequential product development strategy may yield a larger total profit for the firm than developing the new products simultaneously.

Managing product variety in a supply chain

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