Abstract: In addition to quality improvement, horizontal product line extension is often used by manufacturers to attract more appearance-focused consumers. Considering both horizontal and vertical product differentiation, this paper examines how quality-differentiated enterprises should strategically design their product lines according to consumers’ aesthetic preferences to optimize profitability. The results show that: (1) When horizontal differentiation is significant, the optimal strategy for both high-quality and low-quality firms is to refrain from horizontally extending their product lines, resulting in a win-win outcome. If horizontal differentiation is small while the difference in production costs is large, both firms choose to horizontally extend their product lines, yet this leads to a “prisoner’s dilemma”. When horizontal differentiation is moderate and production costs are low, the high-quality firm opts for product line extension, whereas the low-quality firm does not. Only when both horizontal differentiation and production cost differences are small does the low-quality firm optimally decide to extend its product line, while the high-quality firm pursues the opposite strategy. (2) A firm’s original product is consistently priced higher than its homogeneous line extensions. Proactive extension allows the firm to secure a price premium for the original product, whereas imitation by rivals forces a reduction in its price. (3) When lacking quality or market advantages or facing unilateral extension by its competitor, an enterprise tends to maximize horizontal differences in product aesthetics to retain a loyal consumer base. In contrast, the competitor tends to homogenize aesthetic designs in their product lines.

Key words: aesthetic preferences, two-dimensional product differentiation, product line extension, pricing strategy