Product Design, Pricing, and Capacity Investment in a Congested Production System

Abstract

We investigate a firm’s product positioning and capacity investment problem for a product that is vertically differentiated according to its design quality level. Customers arrive according to a Poisson process and are heterogeneous in the marginal valuation of the product’s quality level, making product choices to maximize a linear utility function of price and quality level. Resulting product demands are met through capacity investments in a production process, which is modeled as a queuing system. Capacity investment and variable production costs are functions of the processed product’s quality. We develop an integrated marketing-operations model that provides insights into the factors determining the right positioning of the product in terms of quality and pricing, the resulting market coverage, and the effects on production costs and congestion levels of the production process.