A dynamic analysis of the investment in product innovation in a supply chain under reference price effect: competition vs cooperation

Abstract

ABSTRACT This paper aims to investigate the effects of vertical competition or cooperation along a supply chain on product innovation under the reference effect. To this end, we develop game-theoretical models on the cooperative and non-cooperative supply chains and analyse the optimal decisions of the upstream manufacturer and the downstream retailer. Then, the innovation investment levels under vertical competition and under vertical cooperation are compared. We find that whether the innovation investment is higher under vertical competition depends critically on the strength of the reference effect. In particular, although a stronger reference effect lowers the product innovation investment in a cooperative supply chain, it may instead increase the investment in a non-cooperative supply chain if the retailer shares just a small proportion of the sales revenue with the manufacturer. As a result, the product innovation investment can be higher under vertical competition than under vertical cooperation in the presence of reference price effect, and even more so when the reference price effect grows stronger, the product innovation investment becomes more costly, and the demand for the product becomes more sensitive to price but less sensitive to quality.