IDEAS home Printed from https://ideas.repec.org/a/inm/ormksc/v36y2017i5p747-761.html
   My bibliography  Save this article

Product Quality in a Distribution Channel with Inventory Risk

Author

Listed:
  • Kinshuk Jerath

    (Columbia Business School, Columbia University, New York, New York 10027)

  • Sang-Hyun Kim

    (Yale School of Management, Yale University, New Haven, Connecticut 06520)

  • Robert Swinney

    (Fuqua School of Business, Duke University, Durham, North Carolina 27708)

Abstract

In many industries, product design and manufacturing lead times are sufficiently long that both the quality level of a product and the amount of inventory produced must be determined before a firm knows what the actual demand will be. In this paper, we conduct a theoretical analysis of such a setting. We first consider a centralized channel and characterize the optimal decisions by establishing relationships that must hold between the elasticity of cost of quality and the elasticity of revenue and show that quality and inventory are strategic substitutes. Next, we consider a decentralized channel with a wholesale price contract, in which a manufacturer determines quality and wholesale price, while a retailer determines inventory and retail price. We find that, different from the case without endogenous inventory, product quality can be higher in a decentralized channel compared to a centralized channel, and this is because a wholesale price contract shields the manufacturer from inventory risk. For both centralized and decentralized channels, we find that as demand uncertainty increases, quality decreases, while, different from the case without endogenous quality, inventory can be U-shaped. Interestingly, to mitigate the impact of demand uncertainty on profit, quality can be a more effective lever than inventory in a centralized channel; however, in a decentralized channel, quality is less responsive and inventory is more responsive to demand uncertainty than in a centralized channel.

Suggested Citation

  • Kinshuk Jerath & Sang-Hyun Kim & Robert Swinney, 2017. "Product Quality in a Distribution Channel with Inventory Risk," Marketing Science, INFORMS, vol. 36(5), pages 747-761, September.
    • Handle: RePEc:inm:ormksc:v:36:y:2017:i:5:p:747-761
    DOI: 10.1287/mksc.2017.1041
    as

    Download full text from publisher

    File URL: https://doi.org/10.1287/mksc.2017.1041
    Download Restriction: no
    File URL: https://libkey.io/10.1287/mksc.2017.1041?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Jan A. Van Mieghem & Maqbool Dada, 1999. "Price Versus Production Postponement: Capacity and Competition," Management Science, INFORMS, vol. 45(12), pages 1639-1649, December.
    2. J. Miguel Villas-Boas, 1998. "Product Line Design for a Distribution Channel," Marketing Science, INFORMS, vol. 17(2), pages 156-169.
    3. Ganesh Iyer & Chakravarthi Narasimhan & Rakesh Niraj, 2007. "Information and Inventory in Distribution Channels," Management Science, INFORMS, vol. 53(10), pages 1551-1561, October.
    4. Gérard P. Cachon & Robert Swinney, 2011. "The Value of Fast Fashion: Quick Response, Enhanced Design, and Strategic Consumer Behavior," Management Science, INFORMS, vol. 57(4), pages 778-795, April.
    5. Necati Tereyagoglu & Senthil Veeraraghavan, 2012. "Selling to Conspicuous Consumers: Pricing, Production, and Sourcing Decisions," Management Science, INFORMS, vol. 58(12), pages 2168-2189, December.
    6. Preyas Desai & Oded Koenigsberg & Devavrat Purohit, 2004. "Strategic Decentralization and Channel Coordination," Quantitative Marketing and Economics (QME), Springer, vol. 2(1), pages 5-22, March.
    7. Economides, Nicholas, 1999. "Quality choice and vertical integration," International Journal of Industrial Organization, Elsevier, vol. 17(6), pages 903-914, August.
    8. Abel P. Jeuland & Steven M. Shugan, 1983. "Managing Channel Profits," Marketing Science, INFORMS, vol. 2(3), pages 239-272.
    9. Barry Alan Pasternack, 1985. "Optimal Pricing and Return Policies for Perishable Commodities," Marketing Science, INFORMS, vol. 4(2), pages 166-176.
    10. Daniel Granot & Shuya Yin, 2008. "Price and Order Postponement in a Decentralized Newsvendor Model with Multiplicative and Price-Dependent Demand," Operations Research, INFORMS, vol. 56(1), pages 121-139, February.
    11. Hongyan Shi & Yunchuan Liu & Nicholas C. Petruzzi, 2013. "Consumer Heterogeneity, Product Quality, and Distribution Channels," Management Science, INFORMS, vol. 59(5), pages 1162-1176, May.
    12. Jeffrey D. Shulman & Anne T. Coughlan & R. Canan Savaskan, 2009. "Optimal Restocking Fees and Information Provision in an Integrated Demand-Supply Model of Product Returns," Manufacturing & Service Operations Management, INFORMS, vol. 11(4), pages 577-594, December.
    13. K. Sridhar Moorthy & I. P. L. Png, 1992. "Market Segmentation, Cannibalization, and the Timing of Product Introductions," Management Science, INFORMS, vol. 38(3), pages 345-359, March.
    14. K. Sridhar Moorthy, 1984. "Market Segmentation, Self-Selection, and Product Line Design," Marketing Science, INFORMS, vol. 3(4), pages 288-307.
    15. Martin A. Lariviere, 2006. "A Note on Probability Distributions with Increasing Generalized Failure Rates," Operations Research, INFORMS, vol. 54(3), pages 602-604, June.
    16. Hans Sebastian Heese & Jayashankar M. Swaminathan, 2006. "Product Line Design with Component Commonality and Cost-Reduction Effort," Manufacturing & Service Operations Management, INFORMS, vol. 8(2), pages 206-219, May.
    17. Dennis W. Carlton & James D. Dana, 2008. "Product Variety And Demand Uncertainty: Why Markups Vary With Quality," Journal of Industrial Economics, Wiley Blackwell, vol. 56(3), pages 535-552, September.
    18. Xiaowei Xu, 2009. "Optimal Price and Product Quality Decisions in a Distribution Channel," Management Science, INFORMS, vol. 55(8), pages 1347-1352, August.
    19. Tinglong Dai & Kinshuk Jerath, 2013. "Salesforce Compensation with Inventory Considerations," Management Science, INFORMS, vol. 59(11), pages 2490-2501, November.
    20. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
    21. Kinshuk Jerath & Serguei Netessine & Senthil K. Veeraraghavan, 2010. "Revenue Management with Strategic Customers: Last-Minute Selling and Opaque Selling," Management Science, INFORMS, vol. 56(3), pages 430-448, March.
    22. Jiri Chod & Nils Rudi, 2005. "Resource Flexibility with Responsive Pricing," Operations Research, INFORMS, vol. 53(3), pages 532-548, June.
    23. Terry A. Taylor, 2002. "Supply Chain Coordination Under Channel Rebates with Sales Effort Effects," Management Science, INFORMS, vol. 48(8), pages 992-1007, August.
    24. K. Sridhar Moorthy, 1987. "Comment—Managing Channel Profits: Comment," Marketing Science, INFORMS, vol. 6(4), pages 375-379.
    25. Ananth. V. Iyer & Mark E. Bergen, 1997. "Quick Response in Manufacturer-Retailer Channels," Management Science, INFORMS, vol. 43(4), pages 559-570, April.
    26. Martin A. Lariviere & Evan L. Porteus, 2001. "Selling to the Newsvendor: An Analysis of Price-Only Contracts," Manufacturing & Service Operations Management, INFORMS, vol. 3(4), pages 293-305, May.
    27. Harish Krishnan & Ralph A. Winter, 2007. "Vertical Control of Price and Inventory," American Economic Review, American Economic Association, vol. 97(5), pages 1840-1857, December.
    28. Serguei Netessine & Terry A. Taylor, 2007. "Product Line Design and Production Technology," Marketing Science, INFORMS, vol. 26(1), pages 101-117, 01-02.
    29. Preyas S. Desai & Oded Koenigsberg & Devavrat Purohit, 2007. "Research Note--The Role of Production Lead Time and Demand Uncertainty in Marketing Durable Goods," Management Science, INFORMS, vol. 53(1), pages 150-158, January.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Wong, Hartanto & Kim, Kilsun & Chhajed, Dilip, 2021. "Reducing channel inefficiency in product line design," International Journal of Production Economics, Elsevier, vol. 232(C).
    2. Wong, Hartanto & Lesmono, Dharma & Chhajed, Dilip & Kim, Kilsun, 2019. "On the evaluation of commonality strategy in product line design: The effect of valuation change and distribution channel structure," Omega, Elsevier, vol. 83(C), pages 14-25.
    3. Liu, Yan & Shi, Hongyan & Petruzzi, Nicholas C., 2018. "Optimal quality and quantity provisions for centralized vs. decentralized distribution: Market size uncertainty effects," European Journal of Operational Research, Elsevier, vol. 265(3), pages 1144-1158.
    4. Albert Ha & Xiaoyang Long & Javad Nasiry, 2016. "Quality in Supply Chain Encroachment," Manufacturing & Service Operations Management, INFORMS, vol. 18(2), pages 280-298, May.
    5. Lee, Chang Hwan & Rhee, Byong-Duk, 2021. "Retailer-run resale market and supply chain coordination," International Journal of Production Economics, Elsevier, vol. 235(C).
    6. Zhang, Jianqiang & Cao, Qingning & He, Xiuli, 2019. "Contract and product quality in platform selling," European Journal of Operational Research, Elsevier, vol. 272(3), pages 928-944.
    7. Tao Lu & Ying‐Ju Chen & Brian Tomlin & Yimin Wang, 2019. "Selling Co‐Products through a Distributor: The Impact on Product Line Design," Production and Operations Management, Production and Operations Management Society, vol. 28(4), pages 1010-1032, April.
    8. Maher Agi & Xinghao Yan, 2020. "Greening products in a supply chain under market segmentation and different channel power structures," Post-Print hal-02898158, HAL.
    9. Buqing Ma & Chenchen Di & Lu Hsiao, 2020. "Return Window Decision in A Distribution Channel," Production and Operations Management, Production and Operations Management Society, vol. 29(9), pages 2121-2137, September.
    10. Chen, Xiangfeng, 2015. "A model of trade credit in a capital-constrained distribution channel," International Journal of Production Economics, Elsevier, vol. 159(C), pages 347-357.
    11. Hongyan Shi & Yunchuan Liu & Nicholas C. Petruzzi, 2013. "Consumer Heterogeneity, Product Quality, and Distribution Channels," Management Science, INFORMS, vol. 59(5), pages 1162-1176, May.
    12. Palsule-Desai, Omkar D. & Tirupati, Devanath & Shah, Janat, 2015. "Product line design and positioning using add-on services," International Journal of Production Economics, Elsevier, vol. 163(C), pages 16-33.
    13. Caliskan Demirag, Ozgun & Xue, Weili & Wang, Jie, 2021. "Retailers’ Order Timing Strategies under Competition and Demand Uncertainty," Omega, Elsevier, vol. 101(C).
    14. Pnina Feldman & Yiangos Papanastasiou & Ella Segev, 2019. "Social Learning and the Design of New Experience Goods," Management Science, INFORMS, vol. 65(5), pages 1502-1519, April.
    15. Agi, Maher A.N. & Yan, Xinghao, 2020. "Greening products in a supply chain under market segmentation and different channel power structures," International Journal of Production Economics, Elsevier, vol. 223(C).
    16. Hai Che & Chakravarthi Narasimhan & V. Padmanabhan, 2010. "Leveraging uncertainty through backorder," Quantitative Marketing and Economics (QME), Springer, vol. 8(3), pages 365-392, September.
    17. Yunchuan Liu & Tony Haitao Cui, 2010. "The Length of Product Line in Distribution Channels," Marketing Science, INFORMS, vol. 29(3), pages 474-482, 05-06.
    18. Zhang, Shuhua & Tong, Xiangbin & Jin, Xing, 2023. "Contract design and comparison under the opportunity cost of working capital: Buyback vs. revenue sharing," European Journal of Operational Research, Elsevier, vol. 309(2), pages 845-856.
    19. Tang, Christopher S., 2010. "A review of marketing-operations interface models: From co-existence to coordination and collaboration," International Journal of Production Economics, Elsevier, vol. 125(1), pages 22-40, May.
    20. Vishal V. Agrawal & Stylianos Kavadias & L. Beril Toktay, 2016. "The Limits of Planned Obsolescence for Conspicuous Durable Goods," Manufacturing & Service Operations Management, INFORMS, vol. 18(2), pages 216-226, May.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormksc:v:36:y:2017:i:5:p:747-761. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Asher (email available below). General contact details of provider: https://edirc.repec.org/data/inforea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.