Effects of Reactive Capacity on Product Quality and Firm Profitability in an Uncertain Market

How Reactive Capacity Affects Product Quality and Firm Profitability The COVID-19 pandemic exacerbates both supply and demand uncertainties, which have strategically influenced firms’ product quality and targeting decisions. For example, during the pandemic, automakers faced supply shortages for automotive chips because of the upstream suppliers’ limited parts inventory and production capacities, which have prompted the automakers to increase the quality (e.g., producing higher trims with more optional upgrade features) and price of their products to target fewer (high-valuation) consumers. In “Effects of Reactive Capacity on Product Quality and Firm Profitability in an Uncertain Market,” Jiang and Tian study the impacts of the supplier’s reactive capacity and demand uncertainty on product quality and firm profitability under pull contracts in the supply chain. They find that an increase in the supplier’s reactive capacity can lead to higher or lower equilibrium product quality, benefiting the retailer but potentially reducing the supplier’s profit. Interestingly, both the retailer and the supplier can be worse off with a higher probability for the high market state (with more high-valuation consumers). Further, a higher probability for the high market state can lead to lower product quality.