Branding vertical product line extensions

Abstract

Firms that sell vertically differentiated products infrequently roll out multiple products at the same time. In fact, it is often a firm already selling a well-established product that decides to expand up- or downwards when such an opportunity arises. A critical decision in this scenario is whether to introduce the new product under an existing brand. In this paper, we develop a game-theoretic model in which firms expand their product line to cater to a different customer segment, choosing their branding strategy, new product quality, and prices. We find that the firm's optimal branding strategy depends on both the vertical direction of the expansion and the level of competition, and identify a novel interaction effect between these factors. In particular, firms engaged in direct competition employ branding as a commitment device to soften quality competition. When these firms extend their product line upwards, this creates a misalignment between firms' actions and consumer preferences. We also derive conditions under which firms, against conventional wisdom, choose to differentiate their products more when selling them under the same brand. Finally, we characterize the welfare effects of branding in this setting, and argue that our findings are consistent with observations from the car industry.