Implications of Context Effects in Consumer Utility Models for Optimal Product Design and Differentiation

Abstract

Consumer choice models used in optimal product design typically ignore potential context effects by assuming the utility of each product is independent of the attributes of other products in the choice set. We characterize implications of context effects for profit-maximizing designs by deriving the first-order conditions of the design problem under alternative utility formulations, and we propose a utility function that incorporates context effects and has well-defined optimal design solutions for all products in the choice set. We then conduct a discrete choice survey experiment of automobile options and find statistically significant context-effect parameters and superior out-of-sample prediction when context-effect parameters are used in both logit and mixed logit models. These results suggest that context effects can be important in engineering design contexts and have the potential to affect optimal design differentiation.