In this paper, we analyze the effects of functional (horizontal) decentralization by a channel member on the performance of an industrial channel of distribution. We use the model of Eliashberg et al., which describes a channel of distribution consisting of a manufacturer and a value-adding distributor. We allow the distributor to decentralize decision-making between his marketing and production functions. Our results show that functional decentralization at the distributor level increases the price sensitivity of the distributor concerning the price he faces from the manufacturer, causes a shift in the distributor's demand curve, increases the distributor's inventory activities, in terms of both quantity and time frame, and, under certain conditions, increases the manufacturer's inventory. As expected, the decentralized distributor has a less-coordinated pricing policy vis-à-vis the production policy. Using numerical means, we show that functional decentralization can improve the overall channel profitability, i.e., for both manufacturer and distributor. This counter-intuitive result suggests that in our non-repeated perfect information game setting, functional decentralization can yield a Pareto-dominant equilibrium outcome where both the distributor and manufacturer are better off, even though it is only the distributor who is changing his organizational decision-making.
