Strategic Product Variety Choice: Theory and Empirical Evidence

We investigate theoretically and empirically how firms choose their product variety in response to changes in the market environment. We consider a model in which firms decide on the optimal number of products and on the optimal investment in quality. The interplay between these two choices yields to novel predictions on how market conditions shape a firm’s product variety. We find that higher revenue per consumer leads to a reduced number of products, whereas an increase in the number of competitors or a larger share of loyal consumers induces firms to expand their product variety. Using data from the German magazine industry, we find supportive evidence for these predictions.