Examining Double Marginalization Effect for Innovative Product Supply Chain

Examining Double Marginalization Effect for Innovative Product Supply Chain

Wenjing Shen (Drexel University, USA)
DOI: 10.4018/joris.2012010103
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Abstract

Double marginalization effect refers to the phenomenon that when both upstream and downstream firms have monopolistic power, customers pay higher retail price and firms make less profit than when the supply chain is vertically integrated (Tirole, 1988). Although double marginalization effect has been extensively studied in the context of supply chain management for mature products, very limited attention has been given to innovative products whose demand is generated through word-of-mouth effect. The authors study the pricing decisions in a supply chain that sells innovative products. Using a modified Bass diffusion model to capture demand trajectory over time, the authors identify the optimal way for the retailer and supplier to adjust prices when profit is not discounted, and also provide numerical examples when profit is discounted. The authors show that (1) when profit is not discounted the optimal retail prices are adjusted over time, while the optimal wholesale price should be kept as a constant, and (2) double marginalization effect also exists in an innovative product supply chain, but its degree depends on a number of factors, such as the innovation and imitation coefficients.
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Literature Review

Innovative products have received special attention for very long time. Compared to mature products, innovative products exhibit different demand pattern since demand is changing over time throughout the life cycle. Several papers aim at forecasting demand changes. Among these, Rodgers (1976) reviews relevant marketing research on new product adoption and diffusion process. Gatignon and Robertson (1985) provide a framework for diffusion modeling. Brownstone and Train (1998) study how to forecast product penetration with flexible substitutable patterns. They model customer making a purchasing decision among several substitutable products, and apply choice models including “mixed logits” model. Peres, Muller, and Mahajan (2010) provide a recent review on the progress of innovation diffusion and new product growth model. All of these papers study new product demand as a diffusion process, with theoretical roots found in sociology, geology, etc. (Gatignon & Roberston, 1985).

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