Product Offerings and Product Line Length Dynamics∗

This paper provides a model that uses preference heterogeneity to rationalize the crosssectional and intertemporal variation in a firm’s product proliferation strategies. Product-line dynamics arise from shocks to preference heterogeneity. For example, in the potato chip category I study, consumer concerns over fat levels in foods created two desirable alternatives (low fat and zero fat) for each flavor. On the supply side, firms learn about these changing tastes and adapt product lines accordingly. For tractability, the heterogeneity in preference is captured within the nesting parameter in an aggregate nested logit demand model. I find greater preference heterogeneity for smaller packages of chips and for markets with more demographic diversity. The dominant firm in the market bases its decisions primarily on past experience in the market, with the latest preference shocks representing only 30% of the influence in product-line decisions. Gross margins are increased by 5% if firms have perfect information about preference diversity. Costs for product line maintenance constitute about 2% of total revenue. Sunk costs incurred when expanding the product line are estimated to be four times the per-product fixed cost, thereby limiting the flexibility of product-line adjustment. The probability of line length adjustment grows from 70% to 90% under a smooth cost structure. ∗I am grateful to my advisors, Tim Bresnahan, Wes Hartmann, and Petra Moser, for their invaluable guidance, discussion, and encouragement. I would also like to thank Chris Colon, Chen Cheng, Oystein Daljord, Michael Dickstein, Liran Einav, Pedro Gardete, Daniel Grodzicki, Han Hong, Mike Kruger, Brad Larsen, James Lattin, Anqi Li, Harikesh Nair, Sridhar Narayanan, Joe Orsini, Qiusha Peng, Peter Reiss, Gregory Rosston, Navdeep Sahni, Stephan Seiler, Stephen Teng Sun, Paul Wong, Yiqing Xing, Constantine Yannelis, Pai-Ling Yin, and seminar participants at Stanford Department of Economics, Stanford Marketing WIP, Marketing Science Conference in 2014 Atlanta for their helpful comments. The usual disclaimer applies. †Department of Economics, Stanford University, 579 Serra Mall, Stanford, CA 94305-6072. [email protected]