Contract Unobservability and Downstream Competition
36 Pages Posted: 4 Mar 2019
Date Written: February 22, 2019
We consider a supply chain with a manufacturer and two retailers that are contracted through wholesale prices or two-part tariffs. We depart from the literature by assuming that the contract terms between the manufacturer and a retailer are not observed by the rival retailer. While the existing literature typically assumes that contract terms are common knowledge in the market, in practice, contract terms are often not observed by rival retailers. This paper contributes to the literature by studying the effect of contract unobservability on the supply chain performance. We solve the game under the solution concept of a perfect Bayesian equilibrium. We also adopt passive beliefs as an equilibrium refinement criterion. We find that some well-known results established in the supply chain contract literature on observable contracts do not apply when contracts are not observable to competing retailers. In particular, compared with two-part tariff contracts, the manufacturer may benefit from wholesale price contracts when the contract terms are not observable. Moreover, the total industry profit may be also higher under wholesale price contracts. Our results provide an alternative explanation of the popularity of the wholesale price contracts. Members of the supply chain must take the unobservability into account when choosing the contracts. We also provide new insights into downstream merger and delivery costs between the manufacturer and retailers.
Keywords: contract unobservability, downstream competition, wholesale price contract, two-part tariff contract
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