Price competition between manufacturers selling to a common retailer under stock-out-based substitution

We consider two partially substitutable products sold through a two-echelon supply chain, consisting of two manufacturers and one retailer. In case of a stock-out in one of the products, that product’s demand can spill over to the competing product. We analyze the equilibrium pricing decisions of the manufacturers and ordering decision of the retailer in a three stage dynamic game for a single period. We investigate the effect of spillover rates on equilibrium decisions. We also evaluate the impact of spillovers being ignored by one of the manufacturers or all parties in the chain. We find that the retailer’s order decision depends on the relative profitability of the products. As spillover rates increase, price competition between the manufacturers intensifies, and hence the double marginalization effect in the chain is mitigated.