Differentiated or integrated: Capacity and service level choice for differentiated products

Several firms across different product-focused industries, such as Dell, GM and Keurig, offer associated services along with their products. Given that firms routinely offer a portfolio of vertically differentiated products, a crucial question facing such firms is whether such differentiation should also be extended to associated services. Service differentiation lowers cannibalization of the high-quality product by the low-quality product and increases revenues, but it requires dedicated capacity which increases the cost of offering service. This tradeoff is further confounded by the potential loss of service performance due to complexity involved in single set of resources serving multiple segments. Thus, we examine this service strategy decision along the two dimensions: cannibalization concerns and complexity involved in serving multiple segments together. We consider a firm whose customers vary in their willingness-to-pay (WTP) for product quality and their sensitivity to service levels, and can self-select across offered products. We find that even when there is no complexity involved in serving multiple segments, the differentiated service strategy may be preferred purely to prevent cannibalization. With high complexity, cannibalization concerns may increase or decrease the firm's preference for the differentiated service strategy depending on the demand mix of higher and lower WTP customers. Cannibalization also makes the role of total demand size in the service strategy decision more pronounced. Specifically, changes in capacity costs, customer heterogeneity and product differentiation may make the differentiated service strategy more or less attractive depending on the total demand size as well as the demand mix.