Encroachment strategy and revenue-sharing contract for product customization

Abstract

This paper investigates the optimal encroachment strategy of product customization and the revenue-sharing contract in a two-stage supply chain consisting of a contract manufacturer (CM) and an original equipment manufacturer (OEM). In addition to producing and wholesaling standard products for OEM, CM has the motive to manufacture customized products under store brand and encroach the end consumer market. Stackelberg game models with different strategies (encroachment or no-encroachment) under both decentralized and centralized supply chains are explored. Models analyzing CM’s encroachment with product customization are rare. Besides, this paper characterizes both vertical partnership and horizontal competitive relationships between supply chain members. The findings show that it is unprofitable to encroach on the retailing market for CM when the acceptance degree of store brand is low. There is a threshold value of customization level that can gain positive demand. Interestingly, as the Stackelberg leader, OEM always suffers from the encroachment. Then a revenue-sharing contract is designed that can fully integrate the decentralized supply chain and obtain a contract-implementing Pareto zone. Furthermore, a numerical example is developed, demonstrating the validity of the obtained analytical results. On this basis, some suggestions for industry managers are discussed in the form of managerial insights.