Product Decoys: A Supply Chain Perspective

Conventional wisdom suggests that by including a decoy product in the choice set for consumers, a firm can drive consumers to select more profitable non-decoy products. Explanations offered to explain such outcomes are rooted in the psychology of consumer behavior. A scan of retail practice, however, indicates that decoys might also be included in a product assortment for economic reasons. For example, products with very low sales potential are often included in offerings by bricks-and-mortar and online retailers. This leads us to investigate and offer an alternative supply side explanation for the presence of decoy products in a supply chain. More specifically, we show that in a distribution channel with multiple asymmetric manufacturers and a single retailer, there exists the possibility of an equilibrium which includes a decoy product. Such an equilibrium is characterized by the retailer stocking positive quantities of products from a subset of low-cost manufacturers (active manufacturers) and negligible or even zero stock of a decoy product sourced from a higher cost manufacturer. The retailer includes a decoy product in the assortment since it helps to obtain better contractual terms from the active manufacturers. Recognizing this, upstream active manufacturers not only compete for market share but are also induced to cooperate (in setting wholesale prices) so as to ensure that the manufacturer of the decoy product is driven out of the market. We also find that the degree of product substitutability moderates which manufacturer's product is a decoy. Our findings provide theoretical support for industry practice as well as implications for retail assortment decisions.