Price Protection in the PC Industry

Price Protection in the PC Industry

By
Hau L. Lee, V. Padmanabhan, Terry A. Taylor, Seungjin Whang
Management Science.
2000, Vol. 46, Issue 4, Pages 467-482

Price protection is a commonly used practice between manufacturers and retailers in the personal computer (PC) industry, motivated by drastic declines of product values during the product life cycle. It is a form of rebate given by the manufacturer to the retailer for units unsold at the retailer when the price drops during the product life cycle. It is a controversial policy in the PC industry because it is not clear how such a policy benefits the supply chain and its participants. We show that price protection is an instrument for channel coordination. For products with long manufacturing lead times, so the retailer has a single buying opportunity, a properly chosen price protection credit coordinates the channel. For products with shorter manufacturing lead times, so the retailer has two buying opportunities, price protection alone cannot guarantee channel coordination when wholesale prices are exogenous. However, when the price protection credit is set endogenously together with the wholesale prices, channel coordination is restored. In the two-buying-opportunity setting with fixed wholesale prices, we show that price protection has two primary impacts: (1) shifting sales forward in time and (2) increasing total sales. Finally, we present a simple numerical example that suggests, given the current economics of the PC industry, that price protection under fixed wholesale prices may benefit the total chain and the retailer but hurt the manufacturer.