Benefits of Competitive Upward Channel Decentralization

Management Science, 2011

Yunchuan Liu and Rajeev K. Tyagi

Abstract

Upward channel decentralization occurs when firms choose to not manufacture products by themselves, and procure products from upstream suppliers. One of the most commonly given rationales for a firm choosing upward channel decentralization is that an upstream supplier may have a production-cost or expertise advantage over this firm. This paper provides a strategic reason for why upward channel decentralization can benefit firms even when the upstream suppliers do not have any production-cost or expertise advantage. We show that when product positioning/design is endogenous, upward channel decentralization can incentivize competitive firms to differentiate their products more. With more differentiated products, price competition is softened at the downstream level, benefiting the focal downstream firms. We also show how, in this framework where product design decisions are not independent of the channel design decisions, decentralized channels can outperform centralized channels from total-channel-profit perspective. As a secondary contribution, we use this framework to show a new benefit to manufacturers selling through downstream retailers rather than directly. Finally, we examine the implications of our theory for consumer and social welfare, and draw managerial implications.

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