Traditional or drop-shipping? channel choice and product quality

Abstract

Compared to the traditional channel, where a retailer bears the inventory risk, the drop-shipping channel operates with a distinct approach: the retailer avoids stocking products while the manufacturer directly handles stocking and shipping to consumers. Due to the different inventory risk allocations, the two channels have different product qualities and profits for the manufacturer and retailer. In this study, we investigate product quality decision of the manufacturer and delve into the impact of product quality on the manufacturer's and retailer's profitability. First, we find that product quality can be weakly higher in the drop-shipping channel than that in the traditional channel. This is because the drop-shipping channel allows the manufacturer who undertakes demand uncertainty to charge a higher wholesale price, resulting in a higher product quality. Second, our study reveals that the traditional channel can concurrently yield higher profits for the manufacturer and retailer when product quality is considered, which is in contrast to the previous works. Third, in the traditional channel, as demand uncertainty rises, the retailer's production quantity increases, while the manufacturer's product quality decreases. Finally, our results indicate that the product quality is more sensitive to the shipping cost when demand uncertainty is low.