Multi-Product Quality Competition: Impact of Resource Constraints H. Mu ¨ ge Yayla-Ku ¨ llu ¨ Lally School of Management and Technology, Rensselaer Polytechnic Institute, Troy, New York 12180, USA, yaylah@rpi.edu Ali K. Parlaktu ¨ rk, Jayashankar M. Swaminathan Kenan-Flagler Business School, University of North Carolina, Chapel Hill, North Carolina 27599-3490, USA, ali_parlakturk@unc.edu, msj@unc.edu W e study a multi-product firm with limited capacity where the products are vertically (quality) differentiated and the customer base is heterogeneous in their valuation of quality. While the demand structure creates opportunities through proliferation, the firm should avoid cannibalization between its own products. Moreover, the oligopolistic market structure puts competitive pressure and limits the firm’s market share. On the other hand, the firm has limited resources that cause a supply-side fight for adequate and profitable production. We explicitly characterize the conditions where each force dominates. Our focus is on understanding how capacity constraints and competition affect a firm’s product- mix decisions. We find that considering capacity constraints could significantly change traditional insights (that ignore capacity) related to product-line design and the role of competition therein. In particular, we show that when the resources are limited, the firm should offer only the product that has the highest margin per unit capacity. We find that this product could be the diametrically opposite product suggested by the existing literature. In addition, we show that for intermediate capacity levels, whereas the margin per unit capacity effect dominates in a less competitive market, proliferation and cannibalization effects dominate in a more competitive market. Key words: product-line; limited capacity; competition; quality differentiation; OM-marketing interface History: Received: January 2011; Accepted: March 2012, after 1 revision. 1. Introduction Multi-product firms account for 91% of the output in US manufacturing and they often make short- to medium-term adjustments in their product-lines (Bernard et al. 2006). It is reported that 68% of the multi-product US manufacturing firms alter their product mix, 12% by dropping at least one product, 11% by adding at least one product, and 45% by both adding and dropping at least one product in the medium term. However, success of these prod- uct-line decisions depends largely on the firm’s existing production capacity. Many furniture manu- facturers (e.g., Rieke Office Interiors, Elgin, IL) pro- duce custom and standard furniture using the same fixed capacity. In another example, the available capacity of a flexible machine (machining time) is allocated between high-and low-quality products where a higher quality product requires slower machining speeds (smooth finish) thereby taking a longer time to produce. Similarly, Turo Tailor pro- duces both its mass-produced and custom-tailored suits in its factory in Kuopio, Finland (Sieva ¨nen and Peltonen 2006), in which a custom-tailored suit uses more of the available factory time compared with a mass-produced suit. The majority of the firms in services are also multi- product. For example, public or private, many univer- sities are constrained by space for student housing, while they offer a range of dorm room types with dif- ferent sizes and amenities at various prices (Pryor 2006). The cruise line industry is another example where differentiated product-lines are the norm. They offer a wide range of staterooms from small rooms (119 sq. ft.) to luxurious suites with private jacuzzis and grand pianos (> 2000 sq. ft.). In this industry, supply capacity is notoriously limited (Cruise Travel Specialist 2010). There is a backlog for new builds around the world’s shipyards, and refurbishing the existing ships is the rule of the game. Upgrading to premium services is also an option in many informa- tion technology products where users can have access to larger storage space, bandwidth usage, or data- transfer capabilities. In another example, airlines offer differentiated products such as economy, business, and first-class seats. They offer a subset of these prod- ucts in their aircrafts, and passengers self-select from this subset on a specific origin–destination pair. The 603 Vol. 22, No. 3, May–June 2013, pp. 603–614 DOI 10.1111/j.1937-5956.2012.01379.x ISSN 1059-1478|EISSN 1937-5956|13|2203|0603 © 2012 Production and Operations Management Society