Strategic inventory and pricing decision for substitutable products

Abstract

This study investigates the effect that strategic inventory (SI) has on a supply chain consisting of a common retailer and two manufacturers in a two-period decision setting. In each period, participating members set their respective prices to maximize their profits. Additionally, the retailer decides how many products need to be upheld as strategic inventory. We derive the equilibrium under the Bertrand competition and compare this with an equilibrium where two competing upstream manufacturers cooperate, and one of the manufacturers offers a long-term wholesale price commitment to the retailer. The aim is to investigate the following question: Is such a deal between two members beneficial for the overall supply chain? Results demonstrate that every member of the supply chain has the opportunity to receive higher profits if the holding cost is in a certain range for which the retailer can maintain strategic inventory for wholesale prices offered by two manufacturers. Cooperation between two upstream manufacturers can lead to a superior outcome in the absence of strategic inventory, which is not always true if the retailer upholds strategic inventory. The retailer may receive higher profits and consumers need to pay lower prices under commitment contract, and the strategic integration decision may worsen the performance. Moreover, the manufacturers sometimes are better off if they remain decentralized or offer a long-term wholesale price commitment. Cross-price elasticity and market share remain key parameters affecting the two manufacturer’s strategic decisions.