Assortment and inventory decisions with multiple quality levels

We consider the assortment and inventory decisions of a retailer under a locational consumer choice model where products can be differentiated both horizontally (e.g., color of a product) and vertically (e.g., quality of a product). The assortment and quantity decisions affect customer choice and, hence, the demand and sales for each product. In this paper, we investigate two different environments where product availability and assortment affect consumer choice and demand in different ways: make‐to‐order (MTO) and make‐to‐stock (MTS). In the MTO environment, customers order and purchase their most preferred product; that is, stockouts do not occur. In the MTS model, customers buy their most preferred product if it is in stock or do not buy if it is out of stock. In both environments we find conditions under which it is optimal to carry assortments of only a single quality level. In the MTS case, we show that an assortment of mixed quality levels can be optimal only within a narrow range of parameters.