Implications of Provider Output for the Supply Chain

Information and communications technology (ICT) providers offer client firms an increasingly complex and diverse set of services through bundles or tiers. A major decision for the provider is its output, which determines its menu quality. We consider the provider's output decision and firms' choice of tier, as well as how these decisions are moderated by upstream market power and downstream quality competition. We find that, due to the externality that firms' chosen tiers may exert on each other's demand, the tier downgrade in response to improved provider output amplifies as the competition of firms intensifies. Interestingly, the improved provider output can either improve or deteriorate firms' profits and consumer surplus. In the upstream, the provider's choice of output depends on its market power. Nonetheless, the provider sets a higher menu quality where downstream competition is intense. We discuss the important implications of our findings for providers, firms, and policy-makers.