Strategic inventory of original products amid new product launches

Some suppliers adopt a single rollover strategy to periodically introduce new or updated products while phasing out the original versions; however, their retailers may strategically carry the discontinued old products after the launch of the new product. This paper demonstrates the interaction between product innovation and strategic inventory in a bilateral monopoly framework. We model a supplier that sequentially sells two product versions (original and updated) to a retailer in two periods. The supplier determines the innovation level of updated products, and the retailer may carry original products which are exclusively supplied in period 1 to period 2. We find that increased inventory holding costs, which reduce the retailer's incentive to stock the original product, may negatively impact innovation for the updated product but benefit the supply chain members. In addition, due to the supplier’s ability to innovate, the retailer's strategic inventory leads to an uncommon lose-lose situation for both the supplier and the retailer when the inventory holding cost is high, a result which deviates from the strategic inventory literature. Our research suggests that policymakers should use appropriate inventory taxes and subsidies to maintain moderate inventory holding costs in order to foster innovation. Moreover, suppliers should strategically manage retailer inventory costs through customized storage and subsidy contracts to maximize profitability. Lastly, to avoid the lose-lose scenario caused by strategic inventory, supply chain members should consider arranging prior commitments to not hold inventory or employ the use of Vendor Managed Inventory (VMI).