Ali K. Parlaktürk

The Value of Product Variety When Selling to Strategic Consumers

We consider a firm that sells two vertically (quality) differentiated products to strategically forward-looking consumers over two periods, setting the prices dynamically in each period. The consumers are heterogeneous in their evaluations of quality, and strategic in that they decide not only whether and which product variant to buy, but also when to buy, choosing the option that maximizes their utility. We derive the equilibrium of the pricing-purchasing game between the firm and the consumers. We find that the loss due to strategic customer behavior can be less with two product variants compared to the single-product benchmark, which indicates that product variety can serve as a lever when dealing with strategic customers. This benefit exists when the additional product has an inferior cost-to-quality ratio. Because of this benefit, a firm may find it attractive to sell a product variant that would be unprofitable otherwise. However, product variety can also hurt profitability due to strategic customer behavior: A product variant that would be profitable absent strategic customers can in fact be unprofitable. This can happen when customer impatience and firm costs are moderate.

Product-Line Competition: Customization vs. Proliferation

We study a market with customers who have heterogeneous preferences for product attributes. We consider two types of firms that compete on price and product variety: A traditional firm, which chooses a limited set of product configurations, and a customizing firm, which can produce any configuration to order. The traditional firm carries product inventories and experiences a lead-time delay. The customizing firm does not carry inventory, and its customers incur waiting costs until they receive their orders. We assume that the customizing firm has limited capacity in the short run (e.g., when it does not outsource production to high-volume manufacturers). We derive the equilibrium for a duopoly competition between the customizing firm and the traditional firm, study its characteristics, and compare it to a monopoly. We characterize conditions that favor customization under competition. We find that the customizing firms profit is not monotone in the market size and its ease of customization. Similarly, a decline in the traditional firms holding cost may increase or decrease its profit. We show that the unit cost differential between the firms crucially affects the customizing firms ideal market size, its returns from expanding capacity, its product variety, and the way operational improvements affect its performance.

Competitive Customization

We consider a duopoly market with heterogeneous customer tastes. The firms play a two-stage game. First, each firm chooses whether to invest in mass customization, which would enable it to offer customized products that increasingly match each customers ideal product as the chosen customization level increases. A firm that chooses not to invest in mass customization serves a standard product. Second, the firms competitively price their product lines. We characterize each firms investment in mass customization and study its dependence on competitive position, as determined by its cost efficiency and perceived quality vis-a-vis its competitor. We find that the value of mass customization critically depends on the firms competitive position. It may not be desirable even at zero cost due to its negative effect on price competition. A firm with an overall cost and quality disadvantage never unilaterally adopts mass customization. We show that allowing firms to set different prices for each product configuration leads to a broader adoption of mass customization compared to when they are restricted to uniform prices. However, a firms chosen customization level may be higher with uniform prices. Our analysis also helps a customizing firm determine whether to target its process improvement efforts for a lower cost or a higher customization level.

Segmentation Opportunities for a Social Planner: Impact of Limited Resources

In this research note, we investigate segmentation opportunities for social planners such as government agencies, nonprofits, and public organizations. These opportunities arise when the potential products are vertically (quality) differentiated and the consumers are heterogeneous in their preferences toward quality. In these cases, whether to offer quality differentiated products and what quality level to choose are important decisions for a social planner. In this research note, we identify the conditions where it is socially optimal to offer either one homogenous or two quality differentiated products. We find that the resource limitations may result in a single product offering and that the quality of the product depends on the maximum surplus per unit resource consumed by the products. We also compare our findings to a profit-maximizing firm. We find that the resource limitations may cause a profit-maximizing firm to provide a better service to some consumers than the social planner. Contrary to common wisdom, we also show that the capacity limitations may force the social planner to act like a profit-maximizing firm in terms of its pricing and product mix choice.

Competing Through Mass Customization

We consider a market with heterogeneous customer tastes served by a duopoly. In our base model the firms first decide whether to adopt MC, which enables a firm to provide each customer her ideal product configuration. A firm that chooses not to invest in MC serves a standard product. Following investment decisions, the firms competitively price their products. A customer evaluates a product alternative considering its price and misfit relative to her ideal point (and delay in our extended model). We solve for the resulting equilibrium and study its characteristics. We then study the competition between a firm that adopted MC and a firm that continues to sell standard products in more detail extending our base model to account for some key operational differences between these two firms: While the firm selling standard products usually carries product inventories, the firm selling custom products does not carry inventory, it makes-to-order and its customers incur waiting costs until they receive their orders. Our results are useful for characterizing conditions that favor custom and standard products under competition. We find that the value of mass customization critically depends on the firm’s competitive position, determined by its cost efficiency and perceived quality vis-a-vis its competitor: It may not be desirable even at zero cost due to its negative effect on price competition. A firm with an overall cost and quality disadvantage never adopts mass customization. We show that allowing firms to set custom prices for each product configuration leads to a broader adoption of mass customization compared to when they are restricted to uniform prices. Furthermore, we find that a customizing firm’s profit is not monotone in the market size and its ease of customization when competing against a firm selling standard products. We show that its competitive position crucially affects its ideal market size and its returns from improving the ease of customization.

The Value of Commitments When Selling to Strategic Consumers: A Supply Chain Perspective

We consider a decentralized supply chain consisting of a retailer and a supplier that serves forward-looking consumers in two periods. In each period, the supplier and the retailer dynamically set the wholesale and retail price to maximize their own profits. The consumers are heterogeneous in their evaluations of the product and are strategic in deciding whether and when to buy the product, choosing the option that maximizes their utility, including waiting for a price mark-down. We derive the equilibrium and study the value of price and quantity commitments from both the retailer’s and the supplier’s perspective. We find that, while a centralized system always benefits from making price and quantity commitments, this is not true for a firm in a decentralized supply chain due to how the other firm responds to these commitments. We show that the retailer suffers from making a price or quantity commitment and that, similarly, the supplier does not benefit from making a price commitment. In these cases, commitments can harm not only the firm itself but also profitability of the other firm in the supply chain, thereby disadvantaging the entire supply chain. This happens because such commitments aggravate double-marginalization inefficiency in the supply chain. Furthermore, we show eliminating this inefficiency through a coordinating contract (e.g., a two part tariff or quantity discount) makes commitments beneficial.

Are Strategic Customers Bad for a Supply Chain

We consider a manufacturer serving a retailer that sells its product to customers over two periods. Each firm determines its unit price. The retailer orders the product from the manufacturer prior to the beginning of the selling periods. We consider two types of customers: (1) strategic customers who take their future options into account and time their purchases accordingly and (2) myopic customers who consider only their current options. We compare the resulting equilibria for these two scenarios and evaluate the impact of customers’ strategic behavior. We find that strategic customer behavior always benefits the manufacturer. Interestingly, it may also improve the profitability of the retailer and the entire supply chain in some cases. Strategic customer behavior and decentralization are often regarded as detriments to supply chain performance. We find that, however, the combination of these two factors may not result in the worst supply chain performance. When customers are sufficiently patient, a dec...

Customer Choice and Routing in Queueing Networks

We study self-interested routing in stochastic networks, taking into account the discrete stochastic dynamics of such networks. We analyze a two station multiclass queueing network in which the system manager chooses the scheduling rule used, and individual customers choose routes in a self-interested manner. We show that this network can be unstable in Nash equilibrium when the scheduling rule is chosen naively by the system manager. We also design a non-trivial scheduling rule that negates the performance degradation due to self-interested routing and achieves a Nash equilibrium with excellent performance.