Role of Innovation Valuation Uncertainty and Operational Cost Structure on Product Line Design

The rise of innovation-conscious consumers has led to record demand for products with innovative attributes, such as low-sugar foods and sun-protective clothing. This market trend presents a profit-growth opportunity for established companies, which have dominated the market based on traditional attributes, such as the taste of food and the appearance of clothing. Yet, taking advantage of this opportunity is challenging due to the lack of information on consumers’ valuation of innovation and increased operational costs associated with delivering products with innovative attributes.We present a model of a firm developing and producing conventional and innovative products to serve a two-segment market consisting of innovation-conscious and innovation-neutral consumers. We use a two-dimensional differentiation-contingency framework to depict the rich set of possible optimal strategies the firm could use to segment the market and explore how the market environment and the firm’s operational environment affect the firm’s choice of the optimal product strategy.We decompose segmentation into two dimensions allowing us to decouple the effect of the innovation valuation on the firm’s optimal strategy. We find that while high innovation valuation drives the optimal strategy to be differentiated, variability in the innovation valuation drives contingency. The contingency dimension is a novel feature in product line design research and enables the firm to hedge its risk of low customer innovation valuation. The firm’s operational cost structure further leads to different prioritization within the innovative product’s quality dimensions: high development cost (resp. high coupling cost between the two quality dimensions) induces prioritization of the traditional (resp. innovative) quality of an innovative product. We show the robustness of the insights developed extends to generalized valuation distributions and cost structures