Product design strategies in a manufacturer-retailer distribution channel

Product design decision has significant impacts on firm's competitive edge. In a distribution channel, product design strategy of a manufacturer depends not only on its own decisions, but also on the behaviors of its upstream and downstream partners along the channel. This paper investigates the optimal product design strategy of a manufacturer in a two-stage supply chain that consists of an upstream manufacturer and a downstream retailer. Customers are classified into two groups (i.e., two market segments) according to their difference on quality valuations. For each of the two potential market segments, the manufacturer needs to decide if it is beneficial to design a product with appropriate quality level to meet the demand of customers in the market segment. The retailer procures the product from the manufacturer, and then sells to customers at a retail price. By considering the interactions between the manufacturer and the retailer, this paper first describes the product design problem as a manufacturer-dominant Stackelberg game, and presents the optimal product design strategy for the manufacturer. To improve the performance of the supply chain, the revenue-sharing contract is then introduced into the product design problem. It is found that the revenue-sharing contract can perfectly coordinate the distribution channel in the product design problem. Numerical experiments illustrate the impacts of customer characteristics on the optimal product design strategies.