Product‐Line Length as a Competitive Tool

• Author: Michaela Draganska,Dipak C. Jain
• Date: 01 March 2005
• Published date: 01 March 2005
• DOI: http://doi.org/10.1111/j.1430-9134.2005.00032.x

Product-Line Length as a Competitive Tool

MICHAELA DRAGANSKA

Graduate School of Business

Stanford University

Stanford, CA 94305-5015

draganska michaela@gsb.stanford.edu

DIPAK C. JAIN

Kellogg School of Management

Evanston, IL 60208-2001

d-jain@kellogg.northwestern.edu

The increasing number of consumer goods and services offered in recent years

suggests that product-line extensions have become a favored strategy of product

managers. A larger assortment, it is often argued, keeps customers loyal and

allows firms to charge higher prices. There is disagreement, however, about the

extent to which a longer product line translates into higher profits. We develop

an econometric model derived from a game-theoretic perspective that explicitly

considers firms’ use of product-line length as a competitive tool. On the demand

side, we analytically establish the link between consumer choice and the length

of the product line. Based on our derivations, we include a measure of line

length in the utility function to investigate consumer preference for variety

using a brand-level discrete-choice model. The supply side is characterized by

price and line length competition between oligopolistic firms. For the empirical

analysis we use market-level data for the yogurt category. We find that there

are decreasing returns to product-line length. Based on a series of “what-if”

experiments, we derive recommendations for effective product line decisions in

a competitive environment.

1. Introduction

The increasing number of consumer goods and services offered in

recent years suggests that product proliferation and, in particular, line

extensions have become a favored strategy of product managers. Firms

We thank the editor,Daniel Spulber, and two anonymous reviewers for their constructive

feedback. We have also benefited from discussions with Pradeep Chintagunta, Ulrich

Doraszelski, Jean-Pierre Dube, and Mike Mazzeo. Comments and suggestions by partic-

ipants of the 2000 Marketing Science conference in Los Angeles and numerous seminar

audiences are also gratefully acknowledged.

c

2005 Blackwell Publishing, 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington Road,

Oxford OX4 2DQ, UK.

Journal of Economics & Management Strategy,Volume 14, Number 1, Spring 2005, 1–28

2Journal of Economics & Management Strategy

may compete through their product lines in two ways. First, firms

have an incentive to extend their product lines in order to extract more

consumer surplus. For example, by offering a wide range of products

ranging from the BMW Series 3 to the BMW Series 7, BMW is able

to target different segments of consumers. BMW’s strategy of vertical

line extension involves price discrimination according to consumers’

willingness to pay for quality (Mussa and Rosen, 1978; Moorthy, 1984;

Horsky and Nelson, 1992).

Even if products do not differ in price and quality, product lines

may serve as competitive tools. For example, Coca Cola carries Diet

Coke, Decaffeinated Coke, Diet Decaffeinated Coke, etc., which all have

the same price and quality but vary in other attributes. This type of line

extension is referred to as horizontal. In this case, product proliferation

cannot be attributed to price discrimination. Rather, firms offer a full

line of variety in order to keep customers loyal to the brand and prevent

switching to competitors (Klemperer, 1995). In this sense, these line

extensions are directly driven by competitive considerations.

A number of empirical studies have documented that by ac-

tively managing their product lines in addition to other marketing-

mix instruments such as price and promotions, managers are better

able to face competitive pressures. For example, by offering broader

product lines, firms can increase their market share and profitability

(Lancaster, 1979; Kekre and Srinivasan, 1990) and preempt competitive

entry (Schmalensee, 1978) as well as soften price competition and

achieve higher margins (Putsis, 1997; Kadiyali et al., 1999). While these

earlier studies have established the effects that product-line length can

have on outcome measures such as market shares or profits, there still

is a number of questions unanswered:

rWhy does overall profitability rise with line length? Is it because more

variety attracts more consumers or because more variety allows a firm

to charge a higher price?

rHow much more can a firm charge if it increases its product-line

length?

rHow can a firm react using line length as a competitive tool to respond

to a competitor’s price decrease?

rWhat if there were no competition in line length? Who gains and who

loses?

To answer these questions we build a market model, where con-

sumers’ choices are affected by the number of variants a firm offers,

and firms compete using prices and product-line lengths as strategic

weapons. Our first task is to gain an understanding of why and how