Cost-Reducing Innovation Collaboration in Supply Chain Management

In a supply chain environment, one supply chain member may invest in its upstream partner to develop innovations for cost reduction. However, in order to sustain such innovation collaboration, all the firms in this chain should be able to profit from the collaboration. This paper considers a particular collaboration in which the buyer invests in its supplier's innovation works that can eventually lead to reduction of the production cost of the supplier. In this paper, we have established a cost-reducing innovation model and analyzed it in a game theory setting. We find that although the collaboration may improve the supply chain's profitability as a whole, it might not be successful due to the prisoner's dilemma when the market demand stays constant. However, when the cost reduction will ultimately increase the market demand, such innovation collaboration may benefit both in certain ways. Numerical examples are employed to illustrate the situation.