The Dynamics of Product Variety Karl Ulrich The Wharton School University of Pennsylvania 547 Huntsman Hall Philadelphia, PA 19104 USA ulrich@wharton.upenn.edu http://opim.wharton.upenn.edu/~ulrich Joint work with Taylor Randall and Karthik Balasubramaniam. Funding for this research has been provided by the Mack Center for Technological Innovation, Emerging Technologies Management Research Progam

“Product variety has been increasing steadily in recent years.” - paraphrasing of many researchers motivating work on management of product variety Definitional Issues: “Variety” The number of different products available in a market. Distinct SKUs; or the theoretical number of “orderable” variants for make-to-order products. Fundamental vs. peripheral variety. Variety w.r.t. attributes vs. number of combinations of attributes. Expected story: Variety has increased because customer needs are increasingly heterogeneous and production systems/supply chains are increasingly flexible. Ulrich

Example Data from DataSources Notebook computers: number of SKUs by company and year 1981-2001 Ulrich

3372 SKUs 1104 SKUs 1201 SKUs 928 SKUs 1249 SKUs 529 SKUs 1563 SKUs 342 SKUs Ulrich

If customer needs are increasingly heterogeneous and processes are increasingly flexible, we would expect SKU Density (1/niche-width) to be increasing… Ulrich

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Observed Regularity (?) SKU Density skus/unit Market Size, units time Ulrich

Plausible Explanations for Dynamics of Product Variety Product variety is strongly related to the portfolios of individual firms. The dynamics of the number of firms in the industry is an important driver of the dynamics of variety. Product portfolios are realizations of plans and strategies crafted 2-5 years in the past. Thus, product variety will exhibit stickiness and the over/undershoot typical of dynamic systems with information delays. There are economies of variety. The “optimal” level of variety is a concave function of market size, assuming some “fixed costs” per variant. And many more: Variety shifts from vertical to horizontal because of changes in supply/demand of fundamental product performance. Industries “figure out” platforms and architectures to lower the cost of variety. Early phase of industry development is characterized by a lot of experimentation and associated higher variety (Sorenson, SMJ, 2000). (your theories here…) Ulrich

No shakeout (inherently fragmented?)… Effect of shakeout… Post shakeout… No shakeout (inherently fragmented?)… Ulrich

No shakeout (inherently fragmented?)… Effect of shakeout… Post shakeout… No shakeout (inherently fragmented?)… Ulrich

1. Industry Dynamics, Product Variety, and Hotelling’s Street Expectations of distribution of potential customers lightweight full featured Example: notebook computers Ulrich

1. Industry Dynamics, Product Variety, and Hotelling’s Street Expectations of distribution of potential customers lightweight full featured Example: notebook computers Ulrich

1. Industry Dynamics, Product Variety, and Hotelling’s Street Expectations of distribution of potential customers lightweight full featured Example: notebook computers Ulrich

2. Product Portfolios are Sticky… firms are stuck with too much or too little. Unexpected demand spike Precipitous erosion of market Ulrich

3. Economies of Variety – static model density attribute market width de Groote (Int. J. of Prod. Econ. 1994) N* = market-width * market-density^1/3 * (1/fixed-costs)^1/3 * “pickiness”^2/3 p' p = d*a/2 a/2 a p + d ( x – a/2) Market Width Ulrich

3. Economies of Variety How does optimal variety change as market width and depth change? attribute As the breadth of a market increases, variety increases proportionally. density attribute attribute density As density of market increases, variety increases, but at a decreasing rate. Ulrich

3. Economies of Variety – Dynamic forces lightweight full featured Conjecture: Markets growth patterns over time shift from expansion of breadth to expansion of depth. density of potential market 1984 1983 1982 1981 1980 price industry evolution allows product lines to be extended in this direction Ulrich

First Cut Model – For a monopolist in a growing market category, would a decrease in SKU density be expected? Assumes constant “set up” or fixed costs per variant over product lifecycle. Ulrich

Integrated Explanation of Dynamics Firm dynamics and Industry shakeout Excess variety is created in initial phases of industry growth. Experimentation Expectations of future market size Niche saturation Firm shake out is associated with elimination of product redundancy. Market growth shifts from width to density Learning, scale efficiencies lead to lower costs, which leads to deeper markets. Optimal to have less variety “per customer” as markets get more dense Flexibility, reduction in costs of providing variety Architectural stability Component industry develops Combinatoric variety Ulrich

Other Interesting Ideas Related to Variety Dynamics Sequential vs. simultaneous population of market spaces. R&D capacity decisions Value of learning from iterations Diminishing returns to investments in fundamental product performance (e.g., S-curve behavior) gives rise to transition to investments in peripheral variety (e.g., fashion, color, style). Establishment of platform and industry standards allows combinatorial variety at relatively low cost. (But, this is generally in the “wrong direction” w.r.t. empirical evidence.) Ulrich

Some Next Steps Deeper examination of causal structure within two product categories Notebook computers and Laser Printers Is there evidence of substantial redundancy and overlap in product lines before the “shakeout.” Do we in fact observe a shift in market growth from “breadth” to “depth” of product lines. Analytic model, particularly of “Story 3: Economies of Variety” Ulrich

So What? Product portfolio decisions are important problems in managerial decision making. An understanding of the fundamental drivers of product variety at an industry level informs a firm acting within that industry. Conjectures: Managerial decision making with respect to product variety is typically reactive and incremental, without a clear understanding of how product lifecycles and the evolution of markets impact variety strategy. One of the root causes of the shake out of firms in industry lifecycles is a failure to gain efficient scale, which may be the result of the pursuit of too much product variety. Ulrich