The Optimal Innovation Decision for an Innovative Supplier in a Supply Chain

We study a supply chain consisting of an upstream supplier who invests in innovation, which increases the value of products to end users, and downstream manufacturers who sell to end users. We analyze the supplier’s optimal innovation decision and show that the supplier’s optimal innovation level is higher with the wholesale price contract than with bilateral bargaining. Moreover, with the wholesale price contract, the downstream competition does not affect the supplier’s optimal innovation decision. However, if the manufacturers and the supplier bargain, the supplier’s optimal innovation level under the downstream competition can be either higher or lower than that under the downstream monopoly, depending on the cost structure. Furthermore, these results are robust under the presence of complementary components suppliers. We also demonstrate that the supplier is better off using the wholesale price contract than using bilateral bargaining. Interestingly, the manufacturers’ profits can also be higher with the wholesale price contract in some cases. In the bargaining case, surprisingly, we find that under certain conditions, the downstream competition hurts the supplier. Lastly, we show that a horizontal merger between two manufacturers may not always benefit them.