Optimal pricing and supply strategy for vertically integrated manufacturers with customer preference and market spillover

Abstract

A vertically integrated manufacturer who produces key components and end products is often faced with the dilemma of whether to become the non-exclusive provider of the key component for other exterior manufacturer who produces end products using purchased key components. This study investigates a pricing game and the supply strategy selection between a vertically integrated manufacturer and an exterior product manufacturer with different customer preference and different cost structure under market spillover. The equilibrium decisions in two scenarios are analyzed: the vertically integrated manufacturer has a higher customer perceived value or a lower customer perceived value than that of the exterior manufacturer. To present the optimal component supply strategy, we clearly identify a generalized closed-supply Pareto zone where the common market is relatively small and establish supply strategy Pareto zones under several specific configurations. In comparison, our analysis shows that the vertically integrated manufacturer with higher customer perception opens the component supply only when it nearly monopolizes the initial market or conducts a relatively strong market spillover with a moderate original market. Improving customer perception or increasing the unit operation cost of either manufacturer will facilitate the open-supply strategy. However, as to the vertically integrated manufacturer with lower customer perception, small original markets with high spillover and large original markets with low spillover encourage him to open the component supply. We also find that, a greater operation cost advantage of the vertically integrated manufacturer narrows the equilibrium open region significantly while a greater operation cost disadvantage expands the equilibrium open region in moderate common markets.