Expert Systems with Applications 39 (2012) 7262–7269

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Expert Systems with Applications

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An approach to competitive product line design using conjoint data

Marija Kuzmanovic ⇑, Milan Martic
Department for Operations Research and Statistics, Faculty of Organizational Sciences, University of Belgrade, Jove Ilica 154, 11000 Belgrade, Serbia

a r t i c l e i n f o a b s t r a c t

Keywords: In today’s highly competitive environment, where market oriented firms aim to maximize profits through
Product line design customer satisfaction, there is an increasing need to design a product line, rather than a single product.
Conjoint analysis The main goal of designing a profit maximizing product line is to target the ‘right product’ to the ‘right
Nash equilibrium customer’. Although conjoint analysis has turned out to be one of the most widely used techniques for
Competition
product line design, it falls to explicitly consider retaliatory reactions from competitors. In this paper,
Product differentiation
we propose a new conjoint-based approach to competitive new product line design, employing the Nash
equilibrium concept. The optimal product line design problem for each firm is formulated as a nonlinear
integer programming problem. In the absence of a closed-form solution, to compute the Nash equilibrium
and to determine the optimal product line, we propose a two-phase procedure: a sequential iterative pro-
cedure in the first phase, and backward induction in the second. To solve the optimization problem in
each of the iterations of the sequential procedure, we used the branch-and-bound method. The proposed
approach is illustrated under several scenarios of competition using previously published conjoint data.
Ó 2012 Elsevier Ltd. All rights reserved.

1. Introduction
In the contemporary business environment characterized by
global market competition, where market oriented firms aim to
maximize profits through customer satisfaction, there is an
increasing need to design a product line, rather than a single prod-
uct. By offering a product line, a firm can customize its products to
the needs of a variety of segments, in order to maximize profits by
satisfying more customers than a single product would. Therefore,
a firm needs to carefully choose the variety of product configura-
tions it wishes to use and their prices, given the costs of the prod-
ucts and the customers’ willingness to pay (Sadeghi & Zandieh,
2011). The main goal of designing a profit maximizing product line
is to target the ‘right product’ to the ‘right customer’. A customer
wants to optimize the utility from a purchase by choosing a prod-
uct that maximizes his surplus. In contrast, the firm wants to max-
imize profits by extracting the customer’s surplus.
The problem of product (line) design has been heavily studied
in literature over the past 30 years. In this field, conjoint analysis
has turned out to be one of the most widely used techniques. It
is a consumer research technique that was developed to provide
a method for determining the relative contributions of multiple
factors to customer satisfaction. Through the use of conjoint anal-
ysis, it is possible to determine which product attributes are
important to certain customers or market segments. A number of
⇑ Corresponding author. Tel.: +381 698893206; fax: +381 113950868.
E-mail addresses: marija.kuzmanovic@fon.bg.ac.rs (M. Kuzmanovic), milan@-
fon.bg.ac.rs (M. Martic).
papers have been devoted to both theoretical advances (for review
see Green & Srinivasan, 1990) as well as practical applications of
conjoint analysis (Green & Krieger, 1992; Kuzmanović, 2006; Sohn
& Ju, 2010; Song, Jang, & Sohn, 2009). Wittink and Cattin (1989),
Wittink, Vriens, and Burhenne (1994) provided a perspective of
the wide use of conjoint analysis, based on a survey of more than
1000 commercial applications.
Substantial effort has further been devoted to the development
of models and procedures for the optimal design of new products
(Albritton & McMullen, 2007; Balakrishnan & Jacob, 1996; Camm,
Cochran, Curry, & Kannan, 2006; Green, Carroll, & Goldberg,
1981; Kohli & Krishnamurti, 1987) and product lines (Alexouda,
2004; Alexouda & Paparrizos, 2001; Chen & Hausman, 2000; Dob-
son & Kalish, 1988, 1993; Green & Krieger, 1985, 1987; Kohli &
Sukumar, 1990; Lin, Shih, Cheng, & Lee, 2011; Nair, Thakur, &
Wen, 1995; Steiner & Hruschka, 2002, 2003) using conjoint data.
While most of these optimization approaches take the current
competitive scenarios into account explicitly, i.e. the existing prod-
ucts of competitors, the competitors’ reactions that can occur as a
response to the introduction of a new, or modification of an exist-
ing product, are neglected. As a result, decisions regarding the de-
sign of a product that are derived from these ‘‘traditional’’
approaches can be optimal only in the short term (Steiner, 2010).
The fact that suitable techniques to estimate general models of
competition using individual-level data have not yet been devel-
oped is stated in literature as the reason why there is a relatively
small number of attempts to view the problems of product and
product line designing in the context of the economic aspects of
competition (Kadiyali, Sudhir, & Rao, 2001). This is particularly

0957-4174/$ - see front matter Ó 2012 Elsevier Ltd. All rights reserved.
doi:10.1016/j.eswa.2012.01.097
 M. Kuzmanovic, M. Martic / Expert Systems with Applications 39 (2012) 7262–7269
expressed in multidimensional problems in which a large number
of variables occur, especially when it comes to discrete variables,
which is the case in conjoint analysis.
However, there are certain significant exceptions in literature
where authors have attempted to incorporate the reactions of com-
petitors into the conjoint-based product designing process as well
(Choi & DeSarbo, 1993; Green & Krieger, 1997; Steiner, 2010).
However, these authors had limited the problem down to optimi-
zation of a single product, usually for a homogeneous market,
while optimization of the product line under competition was
absolutely neglected. To our knowledge, only Steiner (2010) exam-
ined a heterogeneous market, but treated the segments as separate
markets of homogeneous preferences, also limiting the problem to
the choice of a single product. The author did not take into account
the impact of the brand, and the analysis was based on a small
number of attributes, namely two attributes, of which one was
price. Dickson and Ginter (1987) have shown that, even when con-
sumers share the similar preferences towards the attributes of a
product, it would be unusual to expect them all to respond,
let alone equally, to the market offer. It is therefore reasonable to
consider the introduction of a product line into a heterogeneous,
as well as a homogeneous market.
For the modeling of competitive interactions, certain authors
propose the Nash equilibrium concept (Choi & DeSarbo, 1993;
Green & Krieger, 1997), and the sequential tatonnement procedure
for determination of the equilibrium (Choi & DeSarbo, 1993). Only
Steiner (2010) proposed the application of the Stackelberg–Nash
equilibrium concept, and a numerical procedure which is based
on complete enumeration. The procedure involves the calculation
of profits for all possible outcomes of the leader–follower game,
and it is precisely this fact that makes it only efficient for problems
of small scale.
In this paper, we propose a new approach to the design of an
optimal product line for a homogeneous market that is based on
conjoint data, but also takes into account production costs and
the possible reactions of competitors. The product line optimiza-
tion problem is formulated as a nonlinear integer programming
problem, while the Nash equilibrium concept is employed to mod-
el competitive reactions. For designing of the optimal product line
we propose a two-phase procedure. We strive to firstly determine
the optimal set of attributes that form the product differentiation
basis, followed by a set of products with such attribute levels com-
binations that make them optimal for a given objective function in
terms of the Nash equilibrium. In the proposed model, the firm’s
objective can be to either maximize the total profit or maximize
the total market share, but in this paper, we will assume profit
maximizing firms.
The aim of the paper is multifaceted. Firstly, we want to add
to the body of knowledge with a new approach to the designing
an optimal product lines that is able to consider retaliatory reac-
tions. Existing approaches either absolutely neglect the reactions
of competitors, or do not take into account consumer prefer-
ences. Therefore, our approach provides researchers in this field
with a broad perspective related to the planning of a product dif-
ferentiating strategy, and offers them another tool for the predic-
tion of competitor behavior. Secondly, we will confirm the
importance of product differentiation and the introduction of a
product line for even a non-segmented market, or a market for
which heterogeneous consumer preferences were not deter-
mined using conjoint analysis, as well as expand the existing lit-
erature with a new approach for the selection of a competitive
product differentiation base. Thirdly, we tested the performance
of our new approach under different market scenarios and com-
pared it to the performance of the model proposed by Choi and
DeSarbo (1993), thus demonstrating its efficiency and applicabil-
ity in practice.
7263
The paper is organized as follows. Section 2 presents a new
model for product line optimization, based on the aggregate con-
sumer preferences. The procedure used for determining the Nash
equilibrium for the proposed model as well as the procedure for
the selection of an optimal product differentiating strategy, are gi-
ven in Section 3. In Section 4, the proposed approach was tested on
the conjoint data previously published in Kuzmanović (2006). In
order to confirm the effectiveness of our new approach, we exam-
ined the performance of different variants of the proposed model
for certain market scenarios. Section 5 presents the concluding re-
marks that summarize the most important contributions of the pa-
per, providing managerial implications of the model, as well as the
possible directions for further research.
2. Model formulation
In order to stay as close as possible in the research tradition on
competitive product design, we adopt the well-established concept
of a simultaneous product-price game. To determine the prefer-
ences of the respondents we used a linear additive model of
part-worth utilities. According to this model, the utility that con-
sumer i has out of buying the product r from the firm j, is given
by the sum of the part-worth utilities that the consumer attaches
to the individual attribute levels of this product. Formally, this
compensatory conjoint utility function can be represented as
follows:
X Lk
K X
U ijr ¼ bikl xjrkl þ eijr ; i ¼ 1; . . . ; I; j ¼ 1; . . . ; J;
k¼1 l¼1
r ¼ 1; . . . ; Rj ; ð1Þ
where I is the number of respondents; J is the number of competi-
tors (firms); Rj is a number of products of firm j; K is the number of
attributes (), while Lk is the number of levels of attribute k. bikl rep-
resents respondent i’s utility with respect to level l of attribute k.
xjrkl is a (0, 1) variable such that it equals 1 if product r of the firm
j has attribute k at level l, otherwise it equals 0. eijr is a stochastic
error term.
Most researchers agree that a probabilistic choice rule, either
the Bradley–Terry–Luce share-of-utility rule or the logit choice
rule, are appropriate for modeling consumers’ choices (Choi & DeS-
arbo, 1994; Green & Krieger, 1997; Steiner 2010). In this paper, the
logit model is employed:
expðl  U ijr Þ
Pijr ¼ PJ PRm ; i ¼ 1; . . . ; I; j ¼ 1; . . . ; J;
n¼1 m¼1 expðl  U inm Þ
r ¼ 1; . . . ; Rj ; ð2Þ
where Pijr is the probability that respondent i will choose the rth
product of firm j, and l is scaling parameter of the logit model
(l > 0).
Following Choi and DeSarbo (1993), Dobson and Kalish (1993),
Green and Krieger (1997), and Steiner (2010), we will assume that
the unit cost function of each firm represents a linear additive
model of the costs of the individual attribute levels, but also that
the fixed costs do not depend on the characteristics of the product.
Although the estimate of costs of each individual attribute level
can be a very difficult task in real applications, Choi and DeSarbo
(1994) showed that the product configurations are far less sensi-
tive to absolute cost values than the relative magnitude of the cost
levels, and therefore their precise measurement is not necessary. In
accordance with the previous assumption, the unit cost of produc-
tion of the rth product of firm j can be expressed as following:
X
K X
L
cjr ðxjr Þ ¼ cjkl xjrkl ; j ¼ 1; . . . ; J; r ¼ 1; . . . ; Rj ; ð3Þ
k¼1 l¼1
7264 M. Kuzmanovic, M. Martic / Expert Systems with Applications 39 (2012) 7262–7269
where cjkl represents the cost assigned to the lth level of the kth
attribute of the rth product of firm j.
Finally, if we let Q denote the market size, then the problem of
designing a profit maximizing product line becomes the following
nonlinear programming problem:
 
Rj
X    Q X I
exp l  U ijr
max Pj ¼ pjr  cjr xjr   PJ PRm ;
xj
r¼1
I i¼1 n¼1 m¼1 exp ðl  U inm Þ
Lk
X well as the values of the part-worths of its levels, can be a guideline
subject to xjrkl ¼ 1; k ¼ 1; . . . ; K; r ¼ 1; . . . ; Rj ;
l¼1
xjrkl 2 f0; 1g; k ¼ 1; . . . ; K; l ¼ 1; . . . ; Lk ; r ¼ 1; . . . ; Rj ;
Lk
XX
jxjrkl  xjr0 kl j  dj ; K 0j # K; r; r 0 2 Rj ; r – r 0 ;
k2K 0j l¼1
pjr  cjr > 0; r ¼ 1; . . . ; Rj ;
 
Q X I
exp l  U jr
 P Pm  MSj ; r ¼ 1; . . . ; Rj :
I i¼1 Jn¼1 Rm¼1 exp ðl  U nm Þ
In the model (4)–(9), the variables xjrkl make up the elements of ma-
trix xj which describes the Rj product of the jth firm in the feasible
set of possible products. The objective function (4) maximizes the
total profit of firm j which offers a line of Rj products. Constraint
(5) ensures that exactly one level of each attribute is assigned to
each product, while constraint (6) indicates the presence or absence
of any one of the attribute levels in the product configuration. Con-
straint (7) ensures that the products of the same firm differ in a cer-
tain number of attribute levels; for dj = 0, the products of firm j do
not necessarily need to differ from one another, while for dj = aRj
they must differ in at least a attributes. We will show that this con-
straint makes sense even for a homogeneous market. Constraint (7)
is particularly important and is modified depending on the particu-
lar problem. It may be limited to apply only to a certain subset of
attributes, K 0j # K, for the most important attributes for example,
and it can differ from firm to firm. The choice of this subset is par-
ticularly significant since it in itself constitutes the minimal base of
product differentiation, and does not oblige that the products must
differ in only these attributes. Different optimal product lines can
also be obtained for different subsets of attributes. Given that the
result of the firm j’s choice is influenced by the choice of the other
firms, in the Section 3 we will propose a procedure which enables
the selection of an optimal subset of attributes under competition.
Constraint (7) can also be used to avoid unacceptable combina-
tions of attributes levels, for example, two products of a certain
firm that have the same characteristics selling at a different price,
or two products that are significantly different in performance sell-
ing at the same price. Constraint (8) ensures that the unit selling
price of the product is greater than the cost of its production, thus
ensuring that the profit from each individual product of the prod-
uct line is positive. Given that this is a problem of product line opti-
mization aimed at maximizing profits, a firm may have an interest
to restrict the market share of one of its products from below (MSj),
so as not to lose the desired market share on the account of profit
(constraint (9)). This constraint is optional.
Additionally, considering that the Kth attribute is price, we need
to make sure that the level of that attribute is consistent with the
selling price of the given product pjr. Namely, let xjrKl be a (0, 1) vec-
tor of the length LK which indicates the presence (absence) of the
price level l in relation to product r of firm j, and let
p ¼ ½p1 ; . . . ; pLk 0 be the vector of the price level, then pjr = p  xjrKl
is the price assigned to product r of firm j. If the conjoint analysis
also includes the attribute of product Brand, it should be taken into
account when modeling that the levels of this attribute are consis-
tent with the firm that manufactures the given product. Formally,
let the kth attribute of the product be Brand, then the levels of the
kth attribute l = 1, . . . , Lk must be consistent with firm j. However,
the total number of levels of this attribute does not have to match
the total number of firms J, since it is not necessary to consider the
reactions of all the competitors on the market. The importance of
ð4Þ
this attribute, which can in certain cases be extremely great, as
ð5Þ
for the selection of significant competitors whose reactions will be
included in the model if a large number of firms exist on the
market.
ð6Þ
3. Optimal product line selection procedure
ð7Þ Firstly, let us consider the scale of problem (4)–(9). In a model
with K attributes of which one attribute is Brand, and Lk levels as-
ð8Þ
signed to those attributes, the total number of possible products of
Q
the firm j equals N j ¼ Kk¼2 Lk . Considering that each of the firms
manufactures an Rj products, the total number of potential product
 QK 
ð9Þ lines of firm j equals NLj ¼ k¼2 Lk . For the given profit function
Rj
(4) of each of the firms, the Nash equilibrium represents that prod-
uct strategy combination (of the possible NLJj ) given by the matrix
x ¼ ½xj j2J which holds that the deviation of any firm from the gi-
ven strategy cannot lead to an improvement of its position. In other
words, the set of strategies is the Nash equilibrium if no firm has an
interest to deviate from that strategy unilaterally. Formally, this
can be written as:
   
Pj xj ; xJ=j  Pj xj ; xJ=j ; j ¼ 1; . . . ; J: ð10Þ
While the existence and uniqueness of the equilibrium have been
studied extensively for a games with a continuous strategy space
(Friedman, 1990), for a games in a discrete strategy space, such as
the one analyzed here, they have not been generalized. Therefore,
they must be investigated empirically.
In model (4)–(9) the product line strategy is determined by di-
rect manipulation of the attribute levels of the conjoint experiment
design, so the Nash equilibrium represents a simultaneous solution
of the proposed model for all of the competing firms. Determina-
tion of the Nash equilibrium therefore requires finding the best re-
sponse of each competitor to the last move made on the market,
which can be described as an iterative process of adjustment, also
known as the tatonnement process. This procedure was introduced
in literature by Choi, DeSarbo, and Harker (1990), Choi, DeSarbo,
and Harker (1992), and was first applied to Conjoint data by Choi
and DeSarbo (1993).
The algorithm based on sequential tatonnement may be briefly
described as follows: In each iteration t(t = 1, . . .), each of the firms
j (j = 1, . . . , J) observes the existing strategies of the other firms,
where the strategies of the first j  1 firms represent the strategies
chosen in the current iteration (t), and the strategies of the other
firms j + 1 represent the strategies chosen in the previous iteration
(t  1), and depending on this, they choose the particular strategy
(product line) that maximizes their own profit:
  
max Pj xtj ; xt1 ; . . . ; xtj1 ; xt1 t1
jþ1 ; . . . ; xJ ; j ¼ 1; . . . ; J: ð11Þ
xj
Nash equilibrium is reached when all the companies have no
interest in changing its own strategy in the current iteration. The
nonlinear integer problem of profit maximization for each of the
 M. Kuzmanovic, M. Martic / Expert Systems with Applications 39 (2012) 7262–7269
firms in each of the iterations can be solved with the application of
some of the existing methods and software, which in the worst
case gives a local optimum (Choi & DeSarbo, 1993).
The previously described algorithm finds the optimal product
line for firm j for a predefined differentiation base, i.e. set K 0j . The
question is which set of attributes is optimal in competitive
conditions. In the description of constraint (7) of the proposed
model, it states that the sets of attributes K 0j can include only some
of the attributes from the set of all attributes. Based on the
assumption that K  1 is the total number of attributes (excluding
the attribute Brand which is fixed to firm j), and that each of the J
firms manufactures an Rj products, the total number of possible
 
K1
subsets is given by . In practice, the number of attributes
Rj
included in the research and analysis is usually not greater than 10,
and most often ranges up to 6 attributes, so the number of poten-
tial sets K 0j is not great. Each firm j chooses its own subset K 0j , taking
into account the choices of the other firms, so the total number of
outcomes in game with j firms is given by
 j
K 1
B¼ ; j ¼ 1; . . . ; J: ð12Þ
Rj
If we introduce the assumption that firms sequentially decide on
the choice of a differentiation base (leader–follower model), the
procedure for the selection of an optimal differentiation base, and
thus the determination of an optimal product line, can be described
in the following manner. First, for all of the feasible combinations of
subsets K 0j ; j ¼ 1; . . . ; J, it is required to perform product line optimi-
zation and compute equilibrium using sequential iterative proce-
dure. Actually, it should be done B times. The obtained solutions
are then analyzed in the game theory context.
Given that this is finite game with perfect and complete infor-
mation, the solution can be obtained using Subgame perfect Nash
equilibrium (SPNE) concept. The SPNE represents the subset of
strategies x ðK0 Þ ¼ ½xj ðK0 j Þj2J which are the best for all of the firms,
provided that they play the Nash equilibrium in every subgame of
the given game. The subgame perfect equilibrium can further be
determined using backward induction: The firm that has the first
move (the leader) considers what the best response of the other
firms (followers) would be, i.e. what strategy will the followers re-
spond with after they see the move of the leader. The leader then
makes a choice of the particular strategy which will achieve him
the maximum profit for the expected responses of the followers.
The other firms follow this and choose the expected strategy from
the equilibrium as their answer. In the next section, the proposed
procedure will be illustrated on an example.
4. Illustration
4.1. Conjoint data and preliminary analysis
In this section, the proposed model and procedure for the opti-
mal product line design will be illustrated on the conjoint data pre-
viously published in Kuzmanović (2006). Those are results of a
pilot research related to the analysis of the market competition
of printer manufacturers. The conjoint survey included three man-
ufacturers (in this paper labeled as F1, F2 and F3), as well as four
key characteristics of the printers: price, printing speed, the maxi-
mum number of sheets that can be printed with one cartridge, and
the option of double-sided printing. The list of attributes and their
levels, as well as the codes assigned to the attribute levels are given
in Table 1.
Table 1 also presents the results of the research, namely: the
part-worth utilities of all the levels of all attributes at the aggregate
7265
level and the relative importance of each attribute, which repre-
sent the measure of the attribute’s impact on the customer’s
choice. The unit costs of production that are assigned to the levels
of non-price attributes are also given in Table 1. The cost data are
hypothetical because they are not listed in Kuzmanović (2006) and
assumed to be identical across competitors. Fixed costs were not
taken into account. The costs assigned to the attribute Brand refer
to the production costs of a printer with basic characteristics,
which is why the lowest levels of the remaining non-price attri-
butes have been assigned with the value 0, while the introduction
of additional characteristics incurs additional costs. For example,
the introduction of a double-sided printing option increases the
unit cost of production by 60 €.
The conjoint data presented in Table 1 indicate that the exploi-
tation economy of the printer has by far the greatest influence on
the customer’s choice. Namely, the relative importance of the attri-
bute Max equals 35.24%. The attribute Price is in second place by
importance (23.29%), while the least important attribute is Brand
(10.58%).
Bearing in mind part-worths of the attribute levels, it is possible
to determine the most desired printer for a given market, and that
is a printer with the following characteristics: ability to print 16
pages per minute, ability to print over 7000 pages with one car-
tridge, ability to print double-sided and is sold at a price of
320 €. With the selection of printers with these characteristics,
and provided that all three firms exist on a certain market where
the total demand is 100,000 printers, the firm F1 would achieve a
market share of 38.13%, firm F2 would achieve 47.99% and the firm
F3 13.89%. The corresponding profits would amount to
2287.61  103 €, 2879.19  103 € and 833.20  103 €, respectively.
We will mark this scenario as Scenario T0 (see Table 4). If we as-
sume that only the firms F1 and F2 (whose brands are also the
most attractive to consumers) are operating on the market, their
profits and market shares would amount to 2656.51  103 € and
44.28% for F1, and 3343.49  103 € and 55.72% for F2, respectively.
We will mark this scenario as Scenario D0 (see Table 2). In both
scenarios, the market shares are calculated using Eq. (2), while
their placement into the profit function gives the corresponding
values of the profits. The differences in profit and market share
of the firms are the result of different preferences of the respon-
dents towards these three firms.
Nevertheless, the selection of a product that is optimal under
the current market conditions, but does not take into account the
potential reactions of the competitors, can consequently lead to a
suboptimal solution in which the achieved profit is much lower
than expected. In other words, decisions that are based solely on
conjoint data may not be viable in competitive conditions or opti-
mal in terms of maximum profit, which will be presented below
through testing of the approach proposed in this paper.
The model and procedure proposed in the Section 3 were
tested on the data given in Table 1, firstly on an example of a
duopoly, and then a triopoly. The firms that were considered in
the duopoly are firms F1 and F2, towards whose products the
respondents showed significantly greater preference than the
products of firm F3, while the products of all three firms were
considered in the triopoly. The idea was to investigate whether
the exclusion of the least desirable firm’s product from the anal-
ysis affects the equilibrium. In order to make the obtained results
comparable, we firstly performed optimization of the products of
each of the firms under the assumption that they each manufac-
ture only one product, using the model and the procedure pro-
posed by Choi and DeSarbo (1993). We then tested the different
variants of our model under the assumption that the line consists
of two products. The analysis was done for a market in which the
total demand is 100,000 units.
7266 M. Kuzmanovic, M. Martic / Expert Systems with Applications 39 (2012) 7262–7269

Table 1
Aggregate level part-worth utilities and attribute level costs.

Attributes Attribute levels Code Part-worth utilities Attribute importance (%) Cost* (€)
Brand (brand) F1 1 1.56 10.58 100
F2 2 1.79 100
F3 3 0.55 100
Price (price) 320 € 1 2.35 23.29 /
400 € 2 1.94 /
550 € 3 0.38 /
Printing speed (speed) 8 pg/min 1 0.42 15.96 /
12 pg/min 2 1.20 20
16 pg/min 3 2.29 40
Max number of pages (max) Up to 5000 1 1.17 35.24 /
From 5000 to 7000 2 2.13 20
Over 7000 3 2.96 60
Double-sided printing (double) Yes 1 2.20 14.93 60
No 2 0.45 /
*
Hypothetical costs.

Table 2
A comparison of solutions in duopoly market.

Scenario Firm Product Product characteristics Profit* (per product) Profit* (total) Market share Market share
(per product) (%) (total) (%)
D0 F1 R1 1 1 3 3 1 2656.51 2656.51 44.28 44.28
F2 R1 2 1 3 3 1 3343.49 3343.49 55.72 55.72
D1 F1 R1 1 2 3 3 1 6198.53 6198.53 44.28 44.28
F2 R1 2 2 3 3 1 7801.47 7801.47 55.72 55.72
D2 F1 R1 1 2 3 3 1 4316.38 6736.29 30.83 44.28
R2 1 2 3 2 1 2419.91 13.45
F2 R1 2 2 3 3 1 5432.59 8478.29 38.80 55.72
R2 2 2 3 2 1 3045.70 16.92
D3 F1 R1 1 3 3 3 1 2189.15 8218.19 7.55 41.04
R2 1 2 3 2 1 6029.04 33.49
F2 R1 2 2 3 2 1 7588.15 10948.18 42.16 58.96
R2 2 2 3 3 2 3360.03 16.80
D4 F1 R1 1 3 3 3 1 2361.52 8865.29 8.14 44.28
R2 1 2 3 2 1 6503.77 36.13
F2 R1 2 2 3 2 1 8185.64 11157.85 45.48 55.72
R2 2 3 3 3 1 2972.21 10.25
*
In euros  103.

The order of firms was determined in advance; in the case of a
duopoly, the first to make a move is firm F1 followed by firm F2,
while in the case of a triopoly, the order is F1, F2, F3. However, it
should be pointed out that expert manager reasoning would be
necessary during real applications, in order to determine the prod-
uct repositioning sequence as best as possible.
4.2. The Nash equilibrium on a duopoly market
This subsection will present and discuss the application results
of the proposed product line optimization model and its variants,
in the case of a duopoly. Using the data from Table 1, we firstly
determined the profit maximizing Nash equilibrium for each of
the firms according to the model proposed by Choi and DeSarbo
(1993). The optimization results are shown in Table 2 (scenario
D1). In the given scenario, the equilibrium is reached in the third
iteration of the sequential tatonnement procedure. The codes that
indicate the attributes of the selected products are given in the col-
umn ‘‘product characteristics’’ (see Table 1), while the remaining
columns refer to the equilibrium profit and market share, for each
individual product, as well as the total for the entire firm.
In the Nash equilibrium, the market share and profit of firm F1
amounted to 44.28% and 6198.53  103 €, respectively, for a prod-
uct that is characterized by the following characteristics: most eco-
nomical model with the option of double-sided printing, a print
speed of 16 pages per min, and a price of 400 €. The firm F2
achieved a slightly higher market share (55.72%) as well as profit
(7801.47  103 €), by manufacturing a product of the same func-
tional characteristics as firm F1. The result in which both firms pro-
duce an identical product is not unexpected given the assumption
that the costs of production for both firms are identical. The
asymmetry of the profit and market share is a result of the differ-
ent respondent preferences towards the brands of these two firms.
Although the brand itself is not a highly important attribute, its ef-
fect on the market share and profit is not negligible.
When comparing these results with those of Scenario D0, which
does not take into account the potential reactions of competitors
(see Table 2), it can be noted that the model proposed by Choi
and DeSarbo (1993) offers a solution that is not only viable in com-
petitive conditions, but also offers firms a much greater profit. Con-
sidering that the given solution is in equilibrium in the case where
the firms each manufacture one type of product, this scenario can
be considered as referential, i.e. we shall assume that the market is
currently in a state of equilibrium.
Furthermore, under the assumption that firms do not limit the
market share of their products and that the product line of each
firm contains at the most two products, we applied the model pro-
posed in the Section 3. First of all we tested the model for a case
 M. Kuzmanovic, M. Martic / Expert Systems with Applications 39 (2012) 7262–7269
where both firms minimally differentiate their products, with a
change of level of at least one attribute (Scenario D2). For the given
scenario the equilibrium is reached in the third iteration of the
sequential tatonnement procedure (Table 2). Although it seems at
first glance that the obtained solution is better than in the refer-
ence scenario, through detailed analysis it can be established that
the given solution is unsustainable. Namely, both firms in the
equilibrium offer a product with both good and moderately good
characteristics at the same price. Thus, when differentiating prod-
ucts, given the existence of different variable costs associated with
each level, it should also be borne in mind to exclude the possibil-
ity of two products with identical characteristics selling at a differ-
ent price, or products with qualitatively different characteristics
selling at the same price. For precisely this reason, the value 4
has been assigned to parameter dj, j = 1, 2 (two products of the
same firm must differentiate in at least two attributes with two
levels each).
Differentiation base for both firms can consist of any two attri-
butes from the set of all product attributes. For example, for firm F1
these can be the attributes Max and Price, while for firm F2 the
attributes Max and Double. Table 2 presents the Nash equilibrium
for precisely this case (Scenario D3). In the equilibrium, which was
reached in the fourth iteration, both firms manufacture two prod-
ucts each, achieving higher profits than in the case of manufactur-
ing a single product (reference scenario). Firm F1 offers a printer
with all of its attributes are at their best level and a price of
550 €, as well as a printer for which, on account of the reduced
economy (lower level of the attribute Max), the price was also re-
duced to 400 €. Although the profit is higher than in Scenario D1
(8218.19  103 €), the combined market share of firm F1 is slightly
lower (41.04%). For firm F2, it is optimal to set a price of 400 € for
either a moderately economical printer or a printer without a dou-
ble-sided printing option, achieving a total profit of
10948.18  103 € and a market share of 58.96%, which is in both
cases better than the reference scenario.
However, the question arises whether the choice of the differ-
entiation base from the previous scenario is optimal in competitive
conditions? In order to answer that question we will apply the
optimal differentiation base determination approach proposed in
the Section 3. Firstly, through the application of the sequential
tatonnement procedure and the branch-and-bound method for all
possible attribute combinations for both firms, we carried out
product line optimization and calculated the total profits. Table 3
presents the payoff matrix for all B = 36 possible combinations of
differentiation bases, where the payoffs represent the correspond-
ing profits.
Let us consider the data given in Table 3. Only certain combina-
tions of differentiation bases give less favorable results than in the
case of manufacture of a single product (reference scenario). For
firm F1 they are (6, 1), (5, 3), (5, 4), (6, 4), and for firm F2 (4, 1),
(6, 3), (1, 5), (4, 5), (1, 6), (3, 6). In all other outcomes, both firms
achieve better results and higher profits than in the reference sce-
Table 3
Game matrix.
7267
nario. However, there is no outcome that is worse for both firms
than in the reference scenario, i.e. in each of the given outcomes
at least one of the firms achieves a better profit than in the case
of manufacture of a single product, which points us to the conclu-
sion that at least one firm will certainly resort to product
differentiation.
Given that this is a two-player finite game with perfect and
complete information, the equilibrium can be determined using
the procedure proposed in the Section 3. Let us assume as before
that the firms take turns deciding, and that the first firm to make
a move is F1. Firm F1 will consider the potential responses of firm
F2 at all of its own possible strategies. For instance, firm F1 can ex-
pect, if it chooses the strategy (Price, Speed), that firm F2 will
choose the same strategy, realizing a profit of 11186.22  103 €,
while the profit of firm F1 will amount to 7337.14  103 €. The ex-
pected response of firm F2 (which includes selection of a strategy
to achieve maximum profit) to all of the possible strategies of firm
F1 is underlined in each row of the matrix given in Table 3. Out of
the 6 possible strategies, taking into account the best response of
firm F2, the firm F1 will choose the strategy that achieves it the
highest profits. Therefore, the strategy combination ((Price, Max),
(Price, Max)) represents an equilibrium strategy in which firm F1
achieves a profit of 8865.29  103 €, while firm F2 achieves a profit
of 11157.85  103 € (shaded cell in Table 3).
The choice of precisely this differentiation strategy, i.e. attribute
combination, is not surprising given the fact that these two attri-
butes are the most important to consumers, and that the costs as-
signed to the attribute levels are the same for both firms. The
product description as well as the market share and profit of each
product for the given scenario (Scenario D4) are presented in Table
2. The solution is optimal in terms of the differentiation base as
well as the product line design. In the equilibrium, both firms
achieve better results than in all of the previous scenarios. In addi-
tion, the firms are manufacturing printers of the same functional
characteristics. In the case of the first printer, all of the non-price
attributes are at their best level and the printer is offered at a price
of 550 €, while the second, on account of the reduction in the econ-
omy of use, the price is also reduced to 400 €. Although the profit is
higher than in the reference scenario (8865.29  103 € and
11157.85  103 € for firms F1 and F2, respectively), the total mar-
ket shares of both firms remain the same, where the better but
more expensive printer participates with 18.39%, while the
remaining market share is held by the cheaper printer. In relation
to the reference scenario, the price of the printers with the best
functional characteristics has increased, which is consistent with
the idea that differentiation allows firms the possibility to defend
their prices from being brought down to the low end of the poten-
tial price spectrum. The newly introduced printer is cheaper but
has somewhat worse characteristics (but not much worse).
Although its presence on the market is far lower than of the more
expensive one, just the fact that it exists allows firms to set a high-
er price for a better printer.
7268 M. Kuzmanovic, M. Martic / Expert Systems with Applications 39 (2012) 7262–7269

Table 4
A comparison of solutions in triopoly market.

Scenario Firm Product Product characteristics Profit* (per product) Profit* (total) Market share (per product) (%) Market share (total) (%)
T0 F1 R1 1 1 3 3 1 2287.61 2287.61 38.13 38.13
F2 R1 2 1 3 3 1 2879.19 2879.19 47.99 47.99
F3 R1 3 1 3 3 1 833.19 833.19 13.89 13.89
T1 F1 R1 1 2 3 3 1 5337.77 5337.77 38.13 38.13
F2 R1 2 2 3 3 1 6718.12 6718.12 47.99 47.99
F3 R1 3 2 3 3 1 1944.12 1944.12 13.89 13.89
T2 F1 R1 1 2 3 2 1 4335.56 5909.81 24.09 29.51
R2 1 3 3 3 1 1574.25 5.43
F2 R1 2 3 3 3 1 1981.34 7438.09 6.83 37.15
R2 2 2 3 2 1 5456.74 30.32
F3 R1 3 1 3 2 1 1321.89 4138.51 13.22 33.34
R2 3 2 3 3 1 2816.62 20.12
*
In euros  103.

4.3. The Nash equilibrium on a triopoly market
In this subsection, we will analyze and discuss the solution of
the proposed model on the case of a triopoly. Using the data from
Table 1, we performed product line optimization (Scenario T2) for
the same differentiation base as in the case of a duopoly
(K 0j ¼ ðPrice; MaxÞ; j ¼ 1; 2; 3). We compared this solution with
the solution of the model proposed by Choi and DeSarbo (Scenario
T1), and, of course, with Scenario T0 in which the potential reac-
tions of competitors are not taken into consideration. The solution
for all three scenarios is given in Table 4.
Let us firstly consider a scenario in which all three firms pro-
duce only one product (Scenario T1). Just as in the case of a duop-
oly, the optimal product with the best characteristics should be
sold at a price of 400 €, and this applies to all three of the firms.
The influence of firm F3 on the profits and market shares of firms
F1 and F2 is considerable, although the product characteristics in
the optimal solution for these two firms remain the same as in
the case of a duopoly.
In the equilibrium of Scenario T2 (optimal product line design),
all three firms manufacture printers of the same functional charac-
teristics, but there are differences in the prices. Firms F1 and F2
(which have a stronger brand) can afford to have higher prices
for both types of their printers than firm F3. Therefore, it is optimal
for firms F1 and F2 to set a price of 550 € (highest price level) for a
printer with the best characteristics, while the optimum for firm F3
is to set the price at 400 € (medium price level). On account of the
reduction in exploitation economy, all three firms are introducing a
second type of printer at a lower price, the first two firms at a price
of 400 €, and the third firm at a price of 320 €.
Through differentiation of products in this manner, all three
firms achieve higher profits than in the case where they manufac-
ture only one product. This is especially important for firm F3,
which not only increases its market share, but also increases its
profits by more than 2 times. Although the profits of firms F1
and F2 are greatly reduced in the triopoly compared to the duop-
oly, the structure of the optimal solution for both firms has re-
mained the same, so the exclusion of the least attractive firm
from the analysis would not affect the decision related to the selec-
tion of an optimal product line. This is a consequence of the fact
that the unit costs assigned to the attribute levels are the same
for all of the firms. The question is whether the solution and con-
clusions would remain the same in the case of different variable
costs.
5. Conclusions
In this paper we presented a new, profit-oriented model for
designing the optimal product line, based on conjoint and cost
data. The model also includes competitive interactions on the mar-
ket. For the modeling of consumer preferences we used the linear
additive utility function, while we used the logit rule for the mod-
eling of consumer choices. The problem of product line optimiza-
tion is formulated as a nonlinear integer programming problem,
while the concept of the Nash equilibrium was used for the mod-
eling of competitor reactions. In the absence of a closed form solu-
tion, for calculation of the Nash equilibrium and determination of
the optimal product line, we proposed a two-phase procedure: a
sequential iterative procedure in the first phase, and backward
induction in the second. To solve the optimization problem in each
of the iterations of the sequential tatonnement procedure, we used
the B&B method.
The performance of the proposed approach was tested on an
illustrative example and under different market scenarios (duopoly
and triopoly), and for different variants of the proposed model. We
have shown that the solution obtained using our new approach is
significantly better than the solution of a model that does not take
into account the possible reactions of competitors, but also better
than the solution of a model that considers the optimization of
only a single product. We have also shown that the approach pro-
posed in this paper is good for the selection of an optimal differen-
tiation base in competitive conditions, and pointed out the
importance of product differentiation and the introduction of a
product line into a market of homogeneous consumer preferences.
Particularly, we have shown that by optimizing the product line
in the manner proposed in the paper, firms can realize significantly
higher profits, even in markets where the application of conjoint
analysis failed to identify heterogeneous preferences. This is the re-
sult of firms being able to set a higher price for a product with bet-
ter characteristics in the case where they offer a line of products,
than they could if it was the only product in their offer. Further-
more, even when the brand of the product has negligible impor-
tance to the consumers, as was the case in the given study, in
competitive conditions it has a significant impact on both the opti-
mal structure of the product line, as well as the total profit. We
have shown that the proposed approach to product line optimiza-
tion is more suitable for precisely those firms whose brands are
less preferred by consumers.
Our approach is not without limits however, and it can be ex-
panded in several directions. One of them is the introduction of
outside goods into the logit model. The inclusion of outside prod-
ucts, i.e. alternatives, is reasonable if consumers do not consider
buying a product below a certain level of utility value, or if a large
number of firms exists on the market, so that an analysis of their
potential reactions would be numerically too demanding. Sec-
ondly, as in most other studies, our model also treats price as a dis-
crete variable for determining the optimal product line (Choi &
DeSarbo, 1993; Green & Krieger, 1992, 1997). Although this
 M. Kuzmanovic, M. Martic / Expert Systems with Applications 39 (2012) 7262–7269
approach has its advantages, in order to provide a representation of
the market that is as realistic as possible, our model could be
adapted so that it offers the possibility of selecting any price from
a certain price interval. One way to achieve this is linearization, as
is suggested by Choi and DeSarbo (1994). The other way is an
approximation through a nonlinear function which would be a
far better choice because, as can be seen in our example, the
dependence of preferences on price is often not linear, and is even
far from it. Thirdly, we assumed that the order in which the moves
are made is known in advance, so the analysis of different variants
of the sequence of moves would make it possible to determine
whether, and to what extent, does the order affect the optimal
solution. Future research could also be conducted in the direction
of product line optimization for a heterogeneous market, as well
as the application of heuristics for its solving.
Acknowledgement
This research was partially supported by the Ministry of Science
and Technological Development, Republic of Serbia, Project Num-
bers: III44007 and TR33044.
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