Coordination of Decentralized Departments with Existing Sales Interdependencies

Abstract

This study regards a company which consists of two decentralized business units forming a value network. One business unit produces and sells a main product and the other business unit produces and sells a complementary by-product. The company pursues a firm-wide differentiation strategy. The following model assumes that the business unit being responsible for the by-product can implement this firm-wide differentiation strategy by improving, for example, the quality or the functionality of the by-product. Because of the complementary relationship of the products, the by-product and the main product obtain a unique selling proposition through a specific investment in the byproduct. The specific investment is totally defrayed by that business unit acting on its own authority, but it increases the revenue of both business units. Therefore, the allocation of the profit induced by the specific investment is not made fairly. An underinvestment problem arises which endangers the objective of firm-wide profit maximization. Coordination instruments are used to improve the reconciliation between separated business units. This article compares a contribution margin based, a revenue based and a quantity based investment contribution mechanism as coordination instruments for achieving goal congruence between the considered business units inducing eficient production and investment decisions as well as overall profit maximization. The recent literature mostly focuses on profit sharing (e.g. [3]), revenue sharing (e.g. [1] and [2]) or transfer pricing (for an overview see [4]) to coordinate a two-stage value chain of a decentralized company with existing production interdependencies. In contrast to that, this study regards production and investment decisions with existing sales interdependencies in a value network. The remainder of this paper is organized as follows: Section 2 presents the framework and the solution of an equilibrium model using a contribution margin based, a revenue based and a quantity based investment contribution mechanism. In section 3, the performance of these coordination mechanisms is compared on the basis of the expected overall firm profit. Circumstances are identified under witch each investment contribution mechanism dominates the others.