Effects of Reactive Capacity on Product Quality and Firm Profitability in an Uncertain Market

95 Pages Posted: 10 Jan 2019 Last revised: 6 May 2022

See all articles by Baojun Jiang

Baojun Jiang

Washington University in Saint Louis - John M. Olin Business School

Lin Tian

Fudan University, School of Management

Date Written: May 5, 2022

Abstract

In many supply chains, the brand-owning retailer designs product quality and decides the retail price but often outsources its production to suppliers. For products with a short selling season, low reactive capacity in the supply chain requires the supplier to carry out production before the selling season, but the uncertain market demand creates risks of stockout or excess inventory. Supplier’s reactive capacity and demand uncertainty can influence brand owners’ product pricing and quality decisions. For example, during the COVID-19 pandemic, automakers faced supply shortages for automotive chips due to the upstream suppliers’ limited parts inventory and production capacities, which have prompted the automakers to increase the quality (e.g., producing higher trims with more optional upgrade features) and price of their products to target fewer (high-valuation) consumers. This paper studies the impacts of the supplier’s reactive capacity and demand uncertainty on product quality and firm profitability under pull contracts in the supply chain. We find that an increase in the supplier’s reactive capacity can lead to higher or lower equilibrium product quality, benefiting the retailer but potentially reducing the supplier’s profit. Interestingly, both the retailer and the supplier can be worse off with a higher probability for the high market state (with more high-valuation consumers). Further, a higher probability for the high market state can lead to lower product quality.

Keywords: marketing-operations interface, COVID-19, pricing, reactive capacity, quick response, product quality, pull contract, demand uncertainty, channel, supply chain, outsourcing

JEL Classification: D40, D42, D80

Suggested Citation

Jiang, Baojun and Tian, Lin, Effects of Reactive Capacity on Product Quality and Firm Profitability in an Uncertain Market (May 5, 2022). Available at SSRN: https://ssrn.com/abstract=3308215 or http://dx.doi.org/10.2139/ssrn.3308215

Baojun Jiang (Contact Author)

Washington University in Saint Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States
3149353315 (Phone)

HOME PAGE: http://apps.olin.wustl.edu/faculty/Jiang/

Lin Tian

Fudan University, School of Management ( email )

670 Guoshun Road, Yangpu District
Shanghai, 200433
China

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