Integrating Production Costs in Channel Decisions

Production costs are critical in every business. In this research, we explore how variations in the manufacturer's production cost affect both the manufacturer–retailer channel relationship and the manufacturer's and the retailer's choice of a price-setting rule (e.g., a dollar-amount margin or a percentage-based margin). We employ a multidisciplinary approach that combines executive interviews, survey research, and a game-theoretic analytical model. The analytical model shows that both the manufacturer's and the retailer's price-setting rule influences the other party's approach to production cost. Therefore, the manufacturer's and the retailer's optimal choice of a price-setting rule is not invariant, as previous marketing literature has suggested; such choices depend on the shape of the production cost function. Overall, the results offer new insight into the channel outcomes in light of production costs. The empirical results support the analytical results.