Abstract: In order to study the effect of cost reduction on the encroachment of quality-differentiated manufacturers, this paper constructs a utility function of consumers who purchase quality-differentiated products and a supply chain game model among an incumbent manufacturer, an entrant manufacturer and a common retailer. On the basis, the value of the incumbent manufacturer's cost-reduction technology investment, as well as the impact of encroachment and cost reduction on supply chain equilibrium and consumer welfare are analyzed. The results show that, although the cost reduction of the incumbent manufacturer can't prevent entrant manufacturer from entering the market, the incumbent manufacturer still has the incentive to invest in cost-reducing technology, which can increase the difficulty for the entrant manufacturer to enter the market and increase the profit and market share of the incumbent manufacturer. Furthermore, cost reduction will lead to reduction of the wholesale and retail prices of the two quality-differentiated products, and the price competition will intensify. Moreover, regardless of whether the incumbent manufacturer will invest in cost-reducing technology, encroachment will always prompt the incumbent manufacturer and the retailer to implement low-price strategy, which is detrimental to the incumbent manufacturer and beneficial to the retailer. Finally, both cost reduction and encroachment can motivate reluctant consumers to buy products and improve their welfare. However, when consumers buy high-quality products, consumer welfare is not necessarily higher, which depends on the degree of quality difference between the two products.

Key words: cost reduction, market encroachment, pricing, consumer surplus