Abstract
This paper studies dynamic innovation and pricing decisions in a two-echelon supply chain. We model a distribution channel where a seller sells a product to an independent buyer who ultimately sells it to the customers. We refer to innovation as efforts made on the product quality improvement, or on process improvement. Both the players can put innovation efforts over time which in turn may enhance the goodwill of the product in market. The product demand increases with goodwill and decreases with the retail price. The innovation efforts can also impact the unit processing cost of the product at the upstream firm’s end positively or negatively. We model the problem as a Stackelberg differential game in which the seller first announces its wholesale price and innovation efforts over time and the buyer responds by deciding the retail price and its innovation efforts over time. We obtain feedback equilibrium strategies for a central decision maker in centralized channel, and for both the players in a decentralized channel. We also obtain several useful managerial insights using analytical as well as numerical means.
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