Modelling quality as a cooperative advertising coordination mechanism in a decentralised channel using game theory

Abstract

Considering the scarcity of cooperative advertising models on the interaction between product quality and market variables such as price, advertising effort and subsidy, this paper considers the effect of quality in cooperative advertising in a manufacturer-retailer supply channel in which the channel members engage in a Stackelberg game. The manufacturer is the channel leader, while the retailer is the follower. The research adopts the incorporation of product quality into the traditional cooperative advertising model setting through the multiplicative impact of price, advertising and product quality on demand. It considers two channel structures: an unsubsidised channel structure in which the manufacturer does not provide advertising subsidy to the retailer, and a subsidised channel structure in which the manufacturer provides advertising subsidy for retail advertising. It obtains the prices, the advertising effort, the retailer’s payoff and the manufacturer’s payoff for both channel structures. The results reveal that for both subsidised and unsubsidised advertising, increase in retail advertising and retailer’s payoff resulting from quality improvement is limited due to diminishing marginal returns. Also, quality improvement negatively affects the manufacturer’s payoff after a certain quality level. Further, it shows that quality can be substituted for subsidy, and can be used to coordinate the channel.