Service Differentiation and Capacity Strategy for Joint Product-Service Offerings

Several firms offer associated services along with their products. A question facing such firms is whether vertical differentiation in their product line should be extended to associated services. The marketing view encourages service differentiation (lower cannibalization), whereas the operations view favors integration of services (economies of scale). We offer insight into this tradeoff along two dimensions: Complexity involved in serving multiple segments together, and cannibalization potential. 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 two 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 the implications are subtle---cannibalization 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 in the service strategy decision more pronounced. Specifically, changes in key parameters such as capacity cost 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.