Product Differentiation and Capacity Cost Interaction
in Time and Price Sensitive Markets

Tamer Boyaci
tamer.boyaci@mcgill.ca
Faculty of Management
McGill University

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We study a profit-maximizing make-to-order manufacturer (or service) firm selling two substitutable products in a price-and-time-sensitive market.  We assume that there is a standard industry delivery time that the firm cannot control. The objective of the firm is to determine the delivery time of the faster product and appropriately price the two products, taking into consideration the impact of delivery time reduction on capacity requirements and associated costs. We develop a model that integrates pricing and delivery time decisions with capacity requirements and costs, and study scenarios where the firm is constrained in capacity for none, one or both product(s). For each scenario, we derive the optimal prices and the delivery times. Comparing different scenarios, we show how product differentiation decisions are influenced by capacity costs, and how the firm should adapt its differentiation strategy in response to a change in its operating dynamics.

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