Product differentiation design under sequential consumer choice process

We consider a product variety design problem with respect to both vertical and horizontal differentiation dimensions under a sequential consumer choice process. Consumers have heterogeneous valuations for product quality as well as different preferences for product type. We consider two sequential consumer choice processes: a quality-based choice model where consumers consider product quality first and then product type, and a type-based choice model with the reversed order. Under the quality-based model, the category manager can either adopt vertical differentiation strategy or bi-dimensional differentiation strategy, whereas under the type-based model, the category manager can either adopt horizontal differentiation strategy or bi-dimensional differentiation strategy. We characterise the structure of optimal product category and prices for each product differentiation strategy and develop efficient algorithms for the quality-based consumer choice model. We find that under the quality-based choice model, vertical differentiation strategy is more profitable than bi-dimensional differentiation strategy, whereas under the type-based choice model, horizontal differentiation strategy is preferred over bi-dimensional differentiation strategy. The result is robust considering the impact of heterogeneity in consumer choice process. Thus, further differentiation in quality or type is actually not preferred when consumers follow a sequential consumer choice process.