Gaining From Losing a Competition in Product Variety

Abstract

This paper studies the impact of a competing firm’s substantial expansion in product variety, achieved through modularity and delayed differentiation, on the sales and inventory of the focal firm in the market. Intuitively, the firm’s sales are expected to decrease when a competitor increases its product variety, as existing consumers are drawn to the greater range of competing products, resulting in a substitution effect. However, we also emphasize a simultaneous spillover effect, where the dramatic increase in a competitor’s product variety can expand the overall market for all firms (including the focal firm) by attracting new consumers to the market. The net impact thus depends on the tradeoff between the substitution effect and spillover effect, forming an empirical question. To explore this tradeoff and quantify the net impact of a competitor’s substantial increase in product variety on the focal firm’s sales and inventory, we exploit the launch of Coca-Cola’s Freestyle dispenser that offers over 120 beverage products via modularity and delayed differentiation. Our analysis focuses on the treatment effects of the launch of Freestyle on changes in the focal firm’s sales quantity, sales dispersion, and inventory levels. Contrary to common intuition, we find that the focal firm’s total sales remain unchanged following the launch of Freestyle dispensers, but its sales dispersion increases by 2.2%, which in turn leads to a 1.0% increase in inventory levels at distribution centers. The unchanged total sales and increased sales dispersion imply a redistribution of sales among the focal firm’s stock keeping units (SKUs). By analyzing data at the SKU level and the business customer level, we uncover the mechanism behind this sales re-allocation: a 1.9% increase in the sales of the focal firm’s long-tail products at the expense of its star product sales. Meanwhile, we identify a 0.9% increase in sales to retailers and entertainment locations, while sales to restaurants decline. These empirical results help disentangle the substitution and spillover effects on the focal firm’s sales resulting from its competitor’s substantially increased product variety. Managerial implications derived from these findings are discussed.