Pricing and quality level decisions of substitutable products in online and traditional selling channels: game‐theoretical approaches

• DOI: http://doi.org/10.1111/itor.12487
• Author: Faezeh Akhavizadegan,Javad Ansarifar,Ata Allah Taleizadeh
• Published date: 01 September 2019
• Date: 01 September 2019

Intl. Trans. in Op. Res. 26 (2019) 1718–1751

DOI: 10.1111/itor.12487

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RESEARCH

Pricing and quality level decisions of substitutable products

in online and traditional selling channels: game-theoretical

approaches

Ata Allah Taleizadeh, Faezeh Akhavizadegan and Javad Ansarifar

School of Industrial Engineering, College of Engineering, Universityof Tehran, Tehran,Iran

E-mail: taleizadeh@ut.ac.ir [Taleizadeh];f.akhavizadegan@ut.ac.ir [Akhavizadegan];

javad.ansarifar@ut.ac.ir [Ansarifar]

Received 7 December 2016; receivedin revised form 23 October 2017; accepted 26 October 2017

Abstract

This study addresses a pricing problemof two substitutable products in a two-echelon supply chain including

two manufacturers and one retailer. The manufacturers sell their productsthrough two distribution channels,

namely traditional and Internet channels. The linear demand functions of products depend on selling prices,

service value of channels, and quality level of products. Moreover, various market power structures are con-

sidered for the members of the supplychain. This study focuses on the specific game-theoretical approaches to

highlight the effect of marketpower structures and leadership between firms. The manufacturer–leader Stack-

elberg (MSS) game,retailer–leader Stackelberg game (RSS), manufacturer-Bertrand competition (MSB), and

retailer-Bertrand competitions (RSB) are appliedto analyze equilibrium solutions. The models help both man-

ufacturers and retailer not only to maximize their profits but also to see the influences of their powers and

decisions under different strategies. As a result, the leader has enough power to get higher profit, and the

maximum profit of the whole supply chain is affected by the market powers of manufacturers and retailer.

The best strategies for the retailer are those that are based on the RS games. The results illustrate that lower

price does not lead to lower profit, and more sales does not necessarily result in higher profit. Moreover, the

Bertrand strategy considered by the manufacturers to determine their optimal decisions is the best strategy

from the customers’ perspective.

Keywords:pricing; supply chain management; substitutable products; game theory; market power; channel competition

1. Introduction

One of the main managerial tools of both supply chain management and revenue management is

pricing. The optimal pricing decision leads to maximization of profit forretailers and manufacturers

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A. A. Taleizadeh et al. / Intl. Trans. in Op. Res.26 (2019) 1718–1751 1719

in the supply chain. Since the demands are anticipatedbased on the product’s selling price and quality

level, paying more attention to the pricing issue is very important. On the other hand, considering

both traditional and online channels, and also powers of the members of each supply chains, which

have important effects on the profits of all firms, is recommended. In this paper, we simultaneously

study the effects of pricing, channels, market powers, and quality levels of substitutable products.

In order to review and summarize the literature, the main subjects of the literature review section

include pricing, channels, and substitutable product for a comprehensive review.

According to Soon (2011) pricing strategy is used to determine the production quantity, to set the

optimal quality level of product, and to dividethe market shares of firms between different channels.

Like the traditional channel, the Internet is also considered a new channel for direct selling because

of progress in information technology. Mukhopadhyay et al. (2011) explain that direct selling via the

Internet has a several benefits, such as information sharing, demand forecasting, and detecting the

sales trends rapidly and inexpensively. Hewlett-Packard, IBM, Eastman Kodak, Nike, and Apple,

and about 42% of the best and popular suppliers in various industries have applied the Internet as a

direct channel to introduce their products. The supplier presents their product information such as

quality, appearance, usage, and other features on the website in direct selling approach. Purchasing

the product through the Internet channel depends on the credit rating of the supplier, product

quality,supplier’s commitment to the product, and a description of the product. Dissatisfaction and

satisfaction of consumers depend on the heterogeneity of quality level of products with consumer

expectations. Hence, Teo and Yeong (2003) explain that the quality level of product and return

policy are significant characteristics in an online channel.

Giannoccaro and Pontrandolfo (2004) show that the upstream and downstream members of

a supply chain have important roles in deter mining the optimal quality level. The suppliers by

investing on resources play vital role in controlling and improving the quality of products. They

stated that by improving the product’s quality the sale is increased, the market share is enhanced,

and the profit of manufacturers and retailers is also increased.

This research addresses the pricing problem of a two-echelon supply including one common

retailer and two competitive manufacturers. The game theory is applied to develop the equilibrium

prices for two substitutable products, each of which is produced by a manufacturer. The manufac-

turers offer their products in the traditional and online channels. Wholesale prices, retail prices, and

online prices of product must be determined by manufacturers not only based on their own cost

structures but also by considering their competitors simultaneously. The profits and optimal deci-

sions of the manufacturers and retailer are affected by market power structures and the leadership

between firms. Hence, this paper considers these factors to determine the optimal decisions under

various conditions.

EI-Ansary and Stern (1972) show that manufacturers and retailers have different powers to

influence the pricing decisions in marketing channels. Pan et al. (2010) define that the power of

members of the supply chain in a marketing channel as the “ability of one channel member to

control the decision variables in the marketing strategy of another member in a given channel at

a different level of distribution.” Based on the power structures, each member of the supply chain

who has more power play more dominant role than other members. There are several studies, such

as Hsieh and Wu (2009), Choi (1991), Lee and Staelin (1997), Trivedi (1998), Tsay and Agrawal

(2004), Zhao et al. (2012), Wu et al. (2012), and Wei et al. (2013), that focus on the market power

structures in the supply chain for single, substitutable, and complementary products.

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2017 The Authors.

International Transactionsin Operational Research C

2017 International Federation of OperationalResearch Societies

1720 A. A. Taleizadeh et al. / Intl. Trans. in Op. Res.26 (2019) 1718–1751

Due to the importance of the pricing in business to maximize the profit of each firm, several

researchers have used pricing techniques in the recent years. Soon (2011) and Chan et al. (2004)

provide the comprehensive reviews on pricing techniques. The dynamic pricing is studied by Cao

et al. (2012), where the demand rate follows a stochastic pattern. The maximization of expected

discounted revenue for finite or infinite horizon planning is considered a factor to obtain the

optimal pricing policies.Also some researchers have limited their research on pricing of substitutable

products.Tang and Yin (2007) propose a model forpricing problem with two substitutable products

to determine the order quantity and selling price of a retailer. Wagner and Friedl (2007) apply a

pricing policy for substitutable products to select and switch between suppliers. The game theory

is applied by Xia (2011) to obtain the optimal decision for pricing of two substitutable products

in a two-echelon supply chain consisting of two suppliers and multiple buyers. The impacts of

price discount contracts and pricing schemes are investigated by Cai et al. (2009) in a supply chain

including two competitive channels. Manufacturer-Stackelberg, retailer-Stackelberg, and vertical

Nash pricing strategies are developed by Choi (1991) to decide the selling prices of substitutable

products.In another research, Choi (2007) studies the pricing of fashion products. Zhao et al. (2014)

study the effects of various pricing strategies and the powers of channel members on optimal pricing

policies of substitutable products. They consider the pricing problem for a two-echelon supply chain

including two manufacturers and one retailer. Ai et al. (2012) study the pricing problem in a supply

chain of substitutable products by considering return policies and uncertain demand. They obtain

the optimal decisions for the selling price, return policies, and clearance pricing. Karakul and Chan

(2008) study a single-period pricing and procurement problem simultaneously for two substitutable

products. Chen and Chang (2013) propose a dynamic model to solve pricing problem of two

substitutable products (new and remanufactured products). Sinha and Sarmah (2010) investigate

the pricing problemof substitutable products in a two-stagesupply chain in terms of the coordination

and competition.

Along with the advancement in information technology, the Internet has become an effective

sale channel through which suppliers can show the product and introduce the new achievements

to the customers. Moreover, the consumers can search their requirements through the Internet

channel and compare the products together rapidly and inexpensively, and purchase the selected

one directly. Jain and Kannan (2002) show that the online direct selling changes the pricing strategies

and type of sale. According to Tsay and Agrawal (2004), online direct selling increases the profit

margins of suppliers. The demand for purchasing through online channel is estimated to increase

from US$155.2 billion in 2009 to approximately US$248 billion in 2014. Mulpuru et al. (2010)

explain that online direct selling outpaces the traditional channel because of its benefit such as

the lower price and greater convenience. By distinguishing the benefit of the online direct selling,

several manufacturers such as Panasonic, Kodak, and Apple have offered their products through

the Internet. Khamseh et al. (2014) developed the MS-Bertrand, RS-Bertrand, and NG models to

formulate a pricing problem considering the market power structure and fuzzy demands. Huang

and Swaminathan (2009) propose four pricing policies to determine the optimal selling price for

different channels of sales. Chiang et al. (2003) and Jain and Kannan (2002) address the pricing

problem in which manufacturer offers his/her products in both traditional and Internet channels.

According to their results, online direct selling enhances the efficiency of marketing efforts and

increases the profits. Chen et al. (2013) propose a model for pricing of two substitutable products

sold by two or more manufacturers. Consumer’s purchasing behavior and various channels for

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2017 The Authors.

International Transactionsin Operational Research C

2017 International Federation ofOperational Research Societies