Supplier's investment in manufacturer's quality improvement with equity holding

This paper considers a supply chain in which an upstream supplier sells a component to a downstream manufacturer facing a price and quality sensitive demand. The supplier has a chance to make investment in the manufacturer, which can not only enable the supplier to hold equity shares in the manufacturer and thus achieve profit sharing with the manufacturer, but also provide resources for the manufacturer to improve its product quality. Under any given investment strategy of the supplier, the equilibrium decisions of the two chain members on wholesale price and profit margin are characterized. Then, the supplier's optimal investment strategy is derived. The paper considers three competition models: supplier Stackelberg (SS), manufacturer Stackelberg (MS), and vertical Nash (VN) models, which correspond to different market power structures. The paper shows that the investment can always increase the market demand. Moreover, in both the SS and VN models, the value of the supplier's investment for the entire supply chain, comes from not only the quality improvement but also the profit sharing caused by equity holding; while in the MS model, the investment value comes only from the quality improvement.