Strategic Decentralization under Sequential Channel Structure and Quality Choices

Abstract Convention wisdom suggests that it is detrimental for a firm to decentralize its sales channel or supply chain structure. However, a persistent research stream has shown that competing firms can benefit from strategic decentralization under one of the two conditions: 1) their products have exogenous quality levels with high substitutability; or 2) their products have endogenous quality levels and decentralization can lead to more quality differentiation. In this paper, we uncover a new strategic benefit of channel decentralization when both conditions are violated. In our model settings, a leader firm (she) and a follower firm (he) first choose their channel structures and then choose from low and high quality levels, which are set so that the two products have low or moderate substitutability. We find that if the leader centralizes, the follower benefits from strategic decentralization only if he has cost advantage in quality development. If the leader decentralizes, the follower benefits from strategic decentralization only if he has cost disadvantage . In short, the follower with cost asymmetry can strategically decentralize his sales channel to influence the leader’s quality choice. We also show the robustness of our results by allowing for a general form of quality development cost function and a positive variable production cost.