Optimizing Store-Brand Quality: Impact of Choice of Producer and Channel Price Leadership

There is a vast literature on optimizing store brand quality, but it does not address the individual and joint effects of sourcing and pricing power; this is the focus of our paper. We study a retailer’s store-brand quality-positioning problem under three sourcing structures and two types of price leadership. The three sources are in-house (IH), a leading national-brand manufacturer (NBM) with a competing product, and a strategic third-party manufacturer (3M). We consider two forms of price leadership, Manufacturer-Stackelberg (MS) and Retailer-Stackelberg (RS). We fully characterize the retailer’s optimal quality levels and their relative values across the six scenarios, as well as equilibrium prices, retail profits, consumer welfare, and supply chain profits. Among other things, we find that the retailer chooses lower quality when sourcing from NBM than from other sources to benefit from quality differentiation as there are few other points of leverage. On the other hand, she chooses a higher quality when sourcing from 3M vs. producing IH because, despite the double marginalization, a higher-quality store brand induces greater competition between 3M and NBM, which benefits the retailer. We also show that the power to decide the source is more important to the retailer than having pricing power.