Quality differentiation in a dual-channel supply chain

In this paper, we investigate a dual-channel supply chain with a retailer (she) and a manufacturer (he) who manufactures a high-quality product and a low-quality one. The manufacturer can distribute the high-quality and low-quality products in a direct channel (e.g., its own online channel) and an indirect channel (e.g., a traditional retailer channel) respectively, or the opposite. Our analyses reveal that the manufacturer's optimal distribution strategy depends on the product type. If the product's customer demand is more sensitive to quality level than production cost, it can be classified as the demand type. For a demand-type product, it is optimal for the manufacturer to sell its premium product through the direct channel to attract more demand. Otherwise, the product can be classified as the cost type and it is optimal for the manufacturer to sell its premium product through the traditional channel. In this way, the relatively high manufacturing cost can be shared with the retailer. Furthermore, we demonstrate the robustness of our results by analyzing an alternate demand model for the dual channels. Finally, we find that the manufacturer's optimal quality differentiation is detrimental to the retailer. Hence, we extend our basic model and show that the retailer can adopt an effective countermeasure by introducing an alternative supplier, even when the supplier charges a higher wholesale price.