Managing Downstream Competition via Capacity Allocation in Symmetric Market

Abstract

AbstractCapacity investment is typically a long-term decision, and capacity adjustments can only be made infrequently. In the short run, mismatches between capacity and demand are inevitable. When capacity lags demand, rationing is necessary. It is the purpose of this paper to study how the mechanism used by the seller to allocate her capacity influences the strategic behavior of the buyers and its impact on the supply chain members’ profits. Consider a supply chain with one supplier and multiple retailers. The supplier produces a single product and sells it to the retailers, who in turn sell the product to consumers. The supplier has limited production capacity. She sets the wholesale price and chooses a mechanism for allocating her capacity in case it is insufficient to satisfy all the retailers’ orders. The retailers determine their order quantities, and are engaged in a Cournot competition at the market level. Notice that the strategic interaction among the retailers occurs not only at the market level but also at the supply level for scare capacity. The wholesale price and the capacity allocation mechanism, both chosen by the supplier, define the game that the retailers play with their order-quantity decisions.