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Managing Supply Risk for Vertically Differentiated Co‐Products
Author(s) -
Bansal Saurabh,
Transchel Sandra
Publication year - 2014
Publication title -
production and operations management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.279
H-Index - 110
eISSN - 1937-5956
pISSN - 1059-1478
DOI - 10.1111/poms.12173
Subject(s) - stockout , business , product (mathematics) , industrial organization , profit (economics) , quality (philosophy) , product differentiation , production (economics) , supply chain , substitution (logic) , substitution effect , commerce , economics , microeconomics , marketing , computer science , philosophy , geometry , mathematics , epistemology , cournot competition , programming language
The manufacturing complexity of many high‐tech products results in a substantial variation in the quality of the units produced. After manufacturing, the units are classified into vertically differentiated products. These products are typically obtained in uncontrollable fractions, leading to mismatches between their demand and supply. We focus on product stockouts due to the supply–demand mismatches. Existing literature suggests that when faced with product stockouts, firms should satisfy all unmet demand of a low‐end product by downgrading excess units of a high‐end product (downward substitution). However, this policy may be suboptimal if it is likely that low‐end customers will substitute with a higher quality product and pay the higher price (upward substitution). In this study, we investigate whether and how much downward substitution firms should perform. We also investigate whether and how much low‐end inventory firms should withhold to strategically divert some low‐end demand to the high‐end product. We first establish the existence of regions of co‐production technology and willingness of customers to substitute upward where firms adopt different substitution/withholding strategies. Then, we develop a managerial framework to determine the optimal selling strategy during the life cycle of technology products as profit margins shrink, manufacturing technology improves, and more capacity becomes available. Consistent trends exist for exogenous and endogenous prices.