Less is More? The Strategic Role of Retailer’s Capacity

Abstract

Retailers are often short on capacity, so a logical assumption would be that retailers could improve their profits by acquiring more. In this study, we show that this is not necessarily true, because retailer’s capacity has a strategic role in channel distribution. Specifically, we consider a setting with multiple suppliers and a common retailer. Our analysis reveals that, first, when the retailer’s capacity is limited, its suppliers will compete head-to-head for the retailer’s capacity, thereby driving down the equilibrium wholesale prices. Second, when the number of suppliers is large, the retailer finds it optimal to limit its own capacity to induce fierce competition among the suppliers. The result also holds when the suppliers and the retailer are contracted through two-part tariffs. Third, when capacity is scarce, the retailer prefers two-part tariffs to wholesale prices, while the suppliers prefer wholesale prices to two-part tariffs. This is because two-part tariffs enhance the retailer’s capacity allocation power, which is translated into retailer profit. Nonetheless, when suppliers can freely choose between two-part tariffs and wholesale prices, they always choose two-part tariffs, leading to a form of prisoner’s dilemma. We also demonstrate the robustness of our findings by considering substitutable and complementary products, exclusive contracts, and positive capacity cost. Our results underscore the importance of considering the retailer’s capacity in channel management.