Equilibrium Analysis of Markup Pricing Strategies Under Power Imbalance and Supply Chain Competition

Abstract

This study uses a game-theory-based analytical model to examine the consequences of two markup pricing schemes, fixed-dollar markup and percentage markup, in a supply chain-to-chain competition setting with power imbalance between dominant retailers. Our results show that the equilibrium pricing strategy depends on the level of supply chain-to-chain competition. Specifically, if the level of supply chain competition is not sufficiently high, the equilibrium pricing strategy for the two retailers will be the one in which both retailers choose to adopt the percentage markup pricing policy, i.e., the [PP] strategy. Unfortunately, this equilibrium will lead the retailers into the prisoner's dilemma in some common situations. However, if the level of competition is extremely high, the equilibrium pricing strategy will be that where the leader (Retailer 1) chooses the percentage markup pricing policy and the follower (Retailer 2) selects the fixed-dollar markup pricing policy, i.e., the [PF] strategy. This equilibrium pricing strategy always hurts Manufacturer 1, but might benefit Manufacturer 2 when the level of competition exceeds a certain threshold. From the perspective of the end-consumers, they prefer the level of competition to be kept below a certain threshold such that the [PP] strategy becomes the equilibrium pricing strategy because this equilibrium leads to the lowest retail prices. Furthermore, our results show that Retailer 1 suffers a first-mover disadvantage even under a linear demand curve, and this situation cannot be alleviated by abandoning its price-leader position to share power equally with Retailer 2.