The impact of demand uncertainty on product line design under endogenous substitution

Abstract

The existing product line design literature devotes little attention to the effect of demand uncertainty. Due to demand uncertainty, the supply‐demand mismatch is inevitable which leads to different degrees of lost sales depending on the configuration of product lines. In this article, we adopt a stylized two‐segment setup with uncertain market sizes and illustrate the interplay between two effects: risk pooling that mitigates the impact of demand uncertainty and market segmentation that facilitates consumer differentiation. Compared to downward substitution, inducing bidirectional substitution through product line decisions including quality levels and prices can yield greater risk pooling effects. However, we show that the additional benefit from the risk pooling effect cannot compensate for the reduced market segmentation effect. We demonstrate that the presence of demand uncertainty can reduce the benefit of market segmentation and therefore the length of product lines in terms of the difference between products. We also propose three heuristics that separate product line and production decisions; each of these heuristics corresponds to one particular form of demand substitution. Our numerical studies indicate that the best of the three heuristics yields performance that is close to optimality. © 2015 Wiley Periodicals, Inc. Naval Research Logistics 62: 143–157, 2015

Quality and pricing decisions in production/inventory systems

“…The articles that are most closely related to our work are those that consider quality and pricing decisions in a manufacturer setting: unfortunately, many of these articles (see, for instance, Netessine and Taylor, 2007, Tang and Yin, 2010, and Rong et al, 2015 do not consider load-dependent lead times (Upasani and Uzsoy, 2008). Those that do, mostly consider make-to-order settings, and focus mainly on optimizing prices and lead time quotes for a single product (see, for instance, Palaka et al, 1998, Ray and Jewkes, 2004, Pekgün et al, 2008, Jayaswal et al, 2011, and Hafızoğlu et al, 2016).…”

Revenue Management for Intermodal Transportation: The Role of Dynamic Forecasting

“…Compared with business-to-customer (B2C) markets, B2B markets feature much higher transaction volume, more contractual agreements, and far less frequent price changes or strategic purchasing behavior. See, for example, Liu and van Ryzin (2008), Elmaghraby and Keskinocak (2008), Rong et al (2015) on B2C strategic behavior. 4 An order is unprofitable if its profit margin falls below the marginal value of reserving current stock for future acceptance.…”

“…See, for example, Liu and van Ryzin (), Elmaghraby and Keskinocak (), Rong et al. () on B2C strategic behavior.…”

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“…With the increasing competition and the rapid change in customers' demand, manufacturers must continually develop series products of multiple grades, which have the same core function but different performance, configuration, and quality, in order to better meet the personalized demands of heterogeneous customers [1]. However, around 80% of product innovation ends in failure each year, even Coca-Cola has developed the new Coke which has been sold in the market for only three months [2]; Apple, which is renowned for innovation, also has developed a Macintosh Portable laptop, Newton handheld computers, QuickTake digital cameras, and other large number of products, which are failures as they did not meet the demands of customers, or their prices were too high [3]. Therefore, it is crucial for manufacturers to make the right decision on developing the right serial products with right function and performance.…”