Product assortment: A dynamic model of competition and cannibalization

A line extension decision by a firm under the risk of cannibalization and competition is essentially a dynamic problem. Firms often decide to launch a successive generation even though they expect the new product to cannibalize their existing products. Firms see the need to obsolete past investments because of future profit opportunities as well as threats from potential new products launched by competing firms. Each firm competes to utilize the next technology that would dominate the market, and that future consumers would value.; This paper focuses on a set of decisions regarding managing a product line over time. We investigate the dynamic effect of a firm's product line strategy considering both competition and cannibalization among products. The focal research problem is the timing and selection of which product to launch in a competitive environment. The questions of when to eliminate existing products, how to allocate resources over a product line, and what price to charge for each product to maximize the firm's future profit stream are also addressed. In this study, firms choose strategies in order to maximize the sum of the expected future profits of all products in their portfolio.; The framework incorporates both a discrete choice model of demand with consumer taste heterogeneity and a dynamic model of supply that allows for optimal product entry, exit, cannibalization, R&D investment, and positioning. The analysis utilizes the Markov Perfect Nash Equilibrium concept. Firms have expectations regarding how the industry will evolve and what will be the competitors' strategic decisions in terms of their product mix offerings. In order to create a dynamic multiproduct firm model in which cannibalization effects within a firm are simultaneously considered with competition effects among firms, the key notions of interdependency among products, market segment structure, and product positioning are modeled in an innovative but parsimonious way.; The dynamic programming algorithm numerically solves for the optimal strategies to be taken by firms. The comprehensive market equilibrium model allows us to explain the reasons behind the competitive dynamics associated with product line extension or reduction decisions and to conduct a number of market simulation experiments to derive strategic implications for product portfolio management.