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.