Strategic Commitment to Price to Stimulate Downstream Innovation under Supplier Competition

It is generally in its supply chain partners' interest for a downstream firm to invest in innovations. However, in response to the downstream firm innovation, the upstream suppliers may have an incentive to opportunistically increase their wholesale prices. The hold-up problem these opportunistic behaviors create leads to the downstream firm to underinvest in innovation. Clearly, this hold-up problem could be eliminated by a pre-commitment to price. However, by making an advance commitment to price, a downstream supplier sacrifices an important means of responding to demand uncertainty. In this paper we research on the trade-off: should it commit to a price in order to encourage innovation, or should it remain flexible in order to respond to demand uncertainty.