Interpretation of product differentiation in linear demand functions
Research in channels of distribution has often started with an assumed parsimonious linear demand function to study the impact of product differentiation on channel structure and channel profits. In this chapter the authors present a four parameter linear demand function, which is intuitively appealing, has a spatial interpretation, reflects the product differentiation concept, allows for heterogeneous tastes, and is rooted in first principles (i.e., starts with a simple utility function). They then discuss the implications of this demand function in terms of two price effects (the effects of average price and price difference), introduce three types of product differentiation, and show various linear demand functions found in the channel management literature can be derived by restricting one or more of their four parameter demand function. As a result, the reader gets deeper insights into the non-intuitive implications of many of the current assumed demand functions. The authors also provide insights on why it is necessary to modify all three parameters of the linear demand function if product placement is altered, that is, one or more products are repositioned.