Product-Line Competition: Customization vs. Proliferation

We study a market with customers who have heterogeneous preferences for product attributes. We consider two types of firms that compete on price and product variety: A traditional firm, which chooses a limited set of product configurations, and a customizing firm, which can produce any configuration to order. The traditional firm carries product inventories and experiences a lead-time delay. The customizing firm does not carry inventory, and its customers incur waiting costs until they receive their orders. We assume that the customizing firm has limited capacity in the short run (e.g., when it does not outsource production to high-volume manufacturers). We derive the equilibrium for a duopoly competition between the customizing firm and the traditional firm, study its characteristics, and compare it to a monopoly. We characterize conditions that favor customization under competition. We find that the customizing firm's profit is not monotone in the market size and its ease of customization. Similarly, a decline in the traditional firm's holding cost may increase or decrease its profit. We show that the unit cost differential between the firms crucially affects the customizing firm's ideal market size, its returns from expanding capacity, its product variety, and the way operational improvements affect its performance.