Strategic Ignorance: Managing Endogenous Demand in a Supply Chain

Abstract

Problem definition: This paper studies a supply chain in which a manufacturer sells a product to consumers through a retailer. The retailer makes an endogenous demand improvement decision on whether or not to increase the potential market base, which is imperfectly observed by the manufacturer. Two common contract types, wholesale price and two-part tariff, are studied. Academic/practical relevance: The existing literature on supply chains with asymmetric information where downstream retailers have better demand information than upstream manufacturers typically assumes that market demand is exogenously given. However, in this paper, market demand can be endogenously affected by the retailer’s demand improvement activities; that is, the retailer decides whether or not to invest in enhancing the product’s demand. This paper contributes to the existing literature by studying how the manufacturer’s capability to acquire demand information affects the retailer’s demand investment decision as well as each firm’s profit. Methodology: Since the manufacturer cannot always observe the retailer’s investment decision, we use game theoretical methods to analyze a perfect Bayesian equilibrium. Results: We find that the retailer benefits from the manufacturer’s increased capability to acquire demand information, i.e., the more accurate the manufacturer’s demand information, the higher the retailer’s profit. We also show that, when the manufacturer can choose the level at which it can acquire demand information, it prefers not to acquire demand information at all under wholesale price contracts and not to acquire perfect demand information under two-part tariff contracts. Managerial implications: Our results offer some new insights into how a manufacturer’s capability to acquire demand information and a retailer’s demand investment decision interact in a supply chain and challenge some well-established results in the exiting literature.