Product Variety and Capacity Investments in Congested Production Systems

We investigate a firm’s product line design, and capacity investment problem for vertically differentiated products along design quality levels. Customers arrive according to a Poisson process and are heterogeneous in their marginal valuation of the quality level. Customers make product choices to maximize a linear utility function of price, quality level, and waiting cost. Resulting product demands are met through capacity investments in production processes, which are modeled as queuing systems. We consider two different types of production processes: product-focused, dedicated to the production of a single product variant; or productflexible, processing all product variants in the product line. Capacity investment and variable production costs are functions of the processed product’s quality. We develop an integrated marketing-operations model that provides insights on the factors determining the right level of product variety to offer, the relative quality positioning of the products in the line, the resulting market coverage and segmentation, and the effects on production costs and congestion levels of the processes. We show that the statistical economies of scale resulting from the congestion phenomena in the production system impose limits on the optimal product variety. For product-focused processes the optimal product variety is captured by an aggregate parameter M , which emphasizes the market size as a facilitator and the per unit capacity investment and customer waiting costs as deterrents for higher product variety. For product-flexible processes optimal product variety depends not only on the above parameter M , but also on the specific type of flexibility and the ratio of capacity investment to variable production costs. Finally, access to full information about customers’ preferences on quality increases the firm’s profitability via higher quality level(s) and increased capacity investments.