Managing Industry 4.0 supply chains with innovative and traditional products: Contract cessation points and value of information

In supply chain management, how contract designs relate to the production system with traditional and Industry 4.0 innovative products (I4I products) is under-explored. In this paper, we fill this literature gap by studying a two-period model in which a manufacturer strategically chooses to incorporate an I4I product line into a traditional product line. In this context, we show that there exists a critical market potential threshold above which the sale of the I4I product is higher than that of the traditional product even when the former is sold at a higher price. For both wholesale price and linear two-part tariff contracts, we show that the contract cessation points and critical market potential threshold behave oppositely. We also find that the innovation level for the I4I product would be higher when the manufacturer’s expected valuation towards the retailer’s cost is higher than the actual one. We extend our base model to demonstrate that the innovation level of the I4I product is higher when the manufacturer uses a linear two-part tariff contract instead of a wholesale price contract. Finally, we uncover that the quantity-dependent innovation investment results in increased profitability and innovation level for the manufacturer provided that the innovation investment coefficient is sufficiently high.