Competing with bandit supply chains

Bandit products have captured significant market shares in China and have started to expand throughout the world. A striking feature of supply chains for bandit products is decentralization, where the upstream firm determines the product quality and the downstream firms compete on prices. We study the competition between a centralized mainstream firm and a decentralized bandit supply chain. We demonstrate that the structural difference between the mainstream firm and the bandit supply chain reduces competition intensity and the quality difference between their products. Surprisingly, the inherent inefficiency in a bandit supply chain, combined with the force of competition, actually leads to both higher product quality and higher price. Furthermore, due to the free‐riding effect, the bandit supply chain may even offer higher quality products than the mainstream firm. The mainstream firm’s profit as a function of the free‐riding effect is U‐shaped, so that free‐riding by the bandit supply chain may eventually benefit the mainstream firm. Finally, decentralization benefits the bandit supply chain when the competition is on product features.