Optimal price and quality decisions of a supply chain game considering imperfect quality items and market segmentation

Imperfect production processes are frequently investigated in supply chain literature. Many recent articles assume that items that do not meet the quality requirements can be sold on a secondary market at a reduced price. Due to simplification, these papers ignore the demand of the secondary customers and assume instead that all imperfect quality items are salable. In this paper, we show that this ignorance can lead to unrealistic results as an unrestricted secondary market may reduce the manufacturer’s incentive for an error-free production process. By introducing a price- and quality-dependent demand for both the primary and secondary markets, we obtain the following main insights: (i) a restricted secondary market leads to more realistic results compared with the unrestricted case; the secondary demand is only ignorable under certain conditions; (ii) quality decisions are mainly influenced by the market parameters of both market segments as well as quality cost parameters; (iii) in some cases, it is advantageous not to serve the secondary market and to concentrate the sales process on primary customers.