Inventory competition and allocation in a multi-channel distribution system

Consider a supply chain involving one manufacturer and one independent retailer. The manufacturer distributes her product to the end consumer through the independent retailer as well as through her direct channel. Each of the two channels faces a stochastic demand. If one channel is out of stock, a fraction of the unsatisfied customers visit the other channel, which induces inventory competition between the channels. Under the scenario described above, will the manufacturer ever undercut the retailer’s order when the capacity is infinite? What are the equilibria of the game? How does a capacity constraint affect the equilibrium outcome? What is the optimal inventory allocation strategy for the manufacturer? Using a game theoretic model we seek answers to the above questions. Both the capacitated and the infinite capacity games are considered. We establish the necessary condition for a manufacturer to undercut a retailer’s order and show that a manufacturer may deny the retailer of inventory even when the capacity is ample. We show that there can be an equilibrium in the capacitated game where a manufacturer might not use the entire capacity and still deny a retailer inventory. We also show that a mild capacity constraint may make both parties better off and thereby increase the total supply chain profit. We develop a simple yet practical contract called the reverse revenue sharing contract and show that along with a fixed franchise fee this contract can coordinates our decentralized supply chain.     

A supply chain model with direct and retail channels

We study a dual channel supply chain in which a manufacturer sells to a retailer as well as to consumers directly. Consumers choose the purchase channel based on price and service qualities. The manufacturer decides the price of the direct channel and the retailer decides both price and order quantity. We develop conditions under which the manufacturer and the retailer share the market in equilibrium. We show that the difference in marginal costs of the two channels plays an important role in determining the existence of dual channels in equilibrium. We also show that demand variability has a major influence on the equilibrium prices and on the manufacturer’s motivation for opening a direct channel. In the case that the manufacturer and the retailer coordinate and follow a centralized decision maker, we show that adding a direct channel will increase the overall profit. Our numerical results show that an increase in retailer’s service quality may increase the manufacturer’s profit in dual channel and a larger range of consumer service sensitivity may benefit both parties in the dual channel. Our results suggest that the manufacturer is likely to be better off in the dual channel than in the single channel when the retailer’s marginal cost is high and the wholesale price, consumer valuation and the demand variability are low.     

An integrated production and inventory model to dampen upstream demand variability in the supply chain

We consider a two-echelon supply chain: a single retailer holds a finished goods inventory to meet an i.i.d. customer demand, and a single manufacturer produces the retailer’s replenishment orders on a make-to-order basis. In this setting the retailer’s order decision has a direct impact on the manufacturer’s production. It is a well known phenomenon that inventory control policies at the retailer level often propagate customer demand variability towards the manufacturer, sometimes even in an amplified form (known as the bullwhip effect). The manufacturer, however, prefers to smooth production, and thus he prefers a smooth order pattern from the retailer. At first sight a decrease in order variability comes at the cost of an increased variance of the retailer’s inventory levels, inflating the retailer’s safety stock requirements. However, integrating the impact of the retailer’s order decision on the manufacturer’s production leads to new insights. A smooth order pattern generates shorter and less variable (production/replenishment) lead times, introducing a compensating effect on the retailer’s safety stock. We show that by including the impact of the order decision on lead times, the order pattern can be smoothed to a considerable extent without increasing stock levels. This leads to a situation where both parties are better off.     

Selling to the “Newsvendor” with a forecast update: Analysis of a dual purchase contract

We consider a supply chain in which a manufacturer sells to a procure-to-stock retailer facing a newsvendor problem with a forecast update. Under a wholesale price contract, the retailer waits as long as she can and optimally places her order after observing the forecast update. We show that the retailer’s wait-and-decide strategy, induced by the wholesale price contract, hinders the manufacturer’s ability to (1) set the wholesale price and maximize his profit, (2) hedge against excess inventory risk, and (3) reduce his profit uncertainty. To mitigate the adverse effect of wholesale price contract, we propose the dual purchase contract, through which the manufacturer provides a discount for orders placed before the forecast update. We characterize how and when a dual purchase contract creates strict Pareto improvement over a wholesale price contract. To do so, we establish the retailer’s optimal ordering policy and the manufacturer’s optimal pricing and production policies. We show how the dual purchase contract reduces profit variability and how it can be used as a risk hedging tool for a risk averse manufacturer. Through a numerical study, we provide additional managerial insights and show, for example, that market uncertainty is a key factor that defines when the dual purchase contract provides strict Pareto improvement over the wholesale price contract.     

Cooperative advertising in a distribution channel with fairness concerns

Cooperative (co-op) advertising has been widely used in practice and employed as a strategy to improve the performance of a distribution channel. It is known from the existing models that co-op advertising could not achieve the channel coordination (i.e., maximize the total channel profit). In this paper, we consider a distribution channel consisting of a single manufacturer and a single retailer, and investigate the effect of the retailer’s fairness concerns. Applying the equilibrium analysis, we obtain the following results: (1) Channel coordination can be achieved if the retailer has fairness concerns and model parameters satisfy certain conditions. (2) Although both channel members become better off with co-op advertising if neither channel member has fairness concerns, we find situations where co-op advertising brings detrimental effects to the retailer if the retailer has fairness concerns. (3) The retailer’s fairness concerns may increase or decrease the equilibrium participation rate, the equilibrium advertising effort, and the equilibrium profit of the manufacturer and the whole channel. (4) We identify the conditions under which the effectiveness of co-op advertising can be improved or reduced by the retailer’s fairness concerns. As long as co-op advertising can bring extra profit to the manufacturer, the retailer’s fairness concerns could improve the effectiveness of the co-op advertising. (5) There exists a Pareto improvement for the profits of both the manufacturer and the retailer when a retailer without fairness concerns becomes fair-minded.     

Retail competition and cooperative advertising

We consider a cooperative advertising channel consisting of a manufacturer selling its product through a retailer in competition with another independent retailer. The manufacturer subsidizes its retailer’s advertising only when a certain threshold is positive. Moreover, the manufacturer’s support for its retailer is higher under competition than in its absence.     

The role of retailer’s performance in optimal wholesale price discount policies

The main goal of this paper is to model the effects of wholesale price control on manufacturer’s profit, taking explicitly into account the retailer’s sales motivation and performance. We consider a stylized distribution channel where a manufacturer sells a single kind of good to a single retailer. Wholesale price discounts are assumed to increase the retailer’s motivation thus improving sales. We study the manufacturer’s profit maximization problem as an optimal control model where the manufacturer’s control is the discount on wholesale price and retailer’s motivation is one of the state variables. In particular in the paper we prove that an increasing discount policy is optimal for the manufacturer when the retailer is not efficient while efficient retailers may require to decrease the trade discounts at the end of the selling period. Computational experiments point out how the discount on wholesale price passed by the retailer to the market (pass-through) influences the optimal profit of the manufacturer.     

Pricing and advertisement in a manufacturer–retailer supply chain

We use a game theoretical approach to study pricing and advertisement decisions in a manufacturer–retailer supply chain when price discounts are offered by both the manufacturer and retailer. When the manufacturer is the leader of the game, we obtained Stackelberg equilibrium with manufacturer’s local allowance, national brand name investment, manufacturer’s preferred price discount, retailer’s price discount, and local advertising expense. For the special case of two-stage equilibrium when the manufacturer’s price discount is exogenous, we found that the retailer is willing to increase local advertising expense if the manufacturer increases local advertising allowance and provides deeper price discount, or if the manufacturer decreases its brand name investment. When both the manufacturer and retailer have power, Nash equilibrium in a competition game is obtained. The comparison between the Nash equilibrium and Stackelberg equilibrium shows that the manufacturer always prefers Stackelberg equilibrium, but there is no definitive conclusion for the retailer. The bargaining power can be used to determine the profit sharing between the manufacturer and the retailer. Once the profit sharing is determined, we suggest a simple contract to help the manufacturer and retailer obtain their desired profit sharing.     

Sales effort free riding and coordination with price match and channel rebate

This paper studies sales effort coordination for a supply chain with one manufacturer and two retail channels, where an online retailer offers a lower price and free-rides a brick-and-mortar retailer’s sales effort. The free riding effect reduces brick-and-mortar retailer’s desired effort level, and thus hurts the manufacturer’s profit and the overall supply chain performance. To achieve sales effort coordination, we designed a contract with price match and selective compensation rebate. We also examined other contracts, including the target rebate contract and the wholesale price discount contract, both with price match. The numerical analysis shows that the selective rebate outperforms other contracts in coordinating the brick-and-mortar retailer’s sales effort and improving supply chain efficiency.     

Make-or-buy service capacity decision in a supply chain providing after-sales service

We consider a supply chain comprising a manufacturer and a retailer. The manufacturer supplies a product to the retailer, while the retailer sells the product bundled with after-sales service to consumers in a fully competitive market. The sales volume is affected by the retailer’s service-level commitment. The retailer can build service capacity in-house at a deterministic price before service demand is realized, or buy the service from an outsourcing market at an uncertain price after service demand realization. We find that the outsourcing market encourages the retailer to make a higher level of service commitment, while prompting the manufacturer to reduce the wholesale price, resulting in more demand realization. We analyze how the expected cost of the service in the outsourcing market and the retailer’s risk attitude affect the decisions of both parties. We derive the conditions under which the retailer is willing to build service capacity in-house and under which it will buy the service from the outsourcing market. Moreover, we find that the manufacturer’s sharing with the retailer the cost to build service capacity improves the profits of both parties.     

Quantity discounts based on the previous order in a two-period inventory model with demand uncertainty

We examine quantity discount contracts between a manufacturer and a retailer in a stochastic, two-period inventory model. The retailer places an order in each of the two periods to meet stochastic demands. The manufacturer gives the retailer a price discount on purchases in the second period in excess of the first-period order quantity (incremental QDP) or a price discount for all units ordered in the second period if the retailer orders more in the second period than in the first period (all-units QDP). We show that the retailer's optimal ordering decision in the second period depends on the sum of initial inventory and previous order quantity. Our computational study suggests that the QDP contract induces the retailer to buy more in the second period but less in the first period, while the increase of the total order quantity may not be significant; and that it increases the manufacturer's profit only when the wholesale margin is large relative to the retail margin.     

Product variety and channel structure strategy for a retailer-Stackelberg supply chain

Motivated by the observations that the direct sales channel is increasingly used for customized products and that retailers wield leadership, we develop in this paper a retailer-Stackelberg pricing model to investigate the product variety and channel structure strategies of manufacturer in a circular spatial market. To avoid channel conflict, we consider the commonly observed case where the indirect channel sells standard products whereas the direct channel offers custom products. Our analytical results indicate that if the reservation price in the indirect channel is sufficiently low, adding the direct channel raises the unit wholesale price and retail price in the indirect channel due to customization in the direct channel. Despite the fact that dual channels for the retailer may dominate the single indirect channel, we find that the motivation for the manufacturer to use dual channels decreases with the unit production cost, while increases with (i) the marginal cost of variety, (ii) the retailer’s marginal selling cost, and (iii) the customer’s fit cost. Interestingly, our equilibrium analysis demonstrates that it is more likely for the manufacturer to use dual channels under the retailer Stackelberg channel leadership scenario than under the manufacturer Stackelberg scenario if offering a greater variety is very expensive. When offering a greater variety is inexpensive, the decentralization of the indirect channel may invert the manufacturer’s channel structure decision. Furthermore, endogenization of product variety will also invert the channel structure decision if the standard product’s reservation price is sufficiently low.     

Coordination via cost and revenue sharing in manufacturer-retailer channels

The problem of establishing efficiency in a manufacturer-retailer channel (channel coordination) is extensively discussed in the industrial economics, the marketing and the operations research literature. However, studies considering consumer demand to be simultaneously affected by price and non-price variables are scarce. One subset of models investigates efficient contracts with non-linear tariffs, but requires mechanisms which are rarely observed in managerial practice. The other subset analyses channel efficiency effects of alternative royalty payments, but omits to design an efficient contract. We contribute to this literature by investigating a contract of royalty payments that is sufficient for channel coordination. Based on the analysis of the underlying vertical externalities, we show that channel coordination requires cost and revenue sharing via a revenue sharing rate and marketing effort participation rates on both manufacturer and retailer level. Some surprising findings are highlighted: there exists a continuum of efficient contracts. Efficiency requires a retailer’s participation of at least 50% in the manufacturer’s cost of marketing effort. Moreover, the elimination of double marginalisation is not necessary for channel coordination. Manufacturer and retailer can choose an efficient contract via bargaining over the wholesale price. The main challenge for managers will be to create acceptance of new types of royalty payments based on a trustful manufacturer-retailer relationship. We also discuss the cases of the Apple iPhone market launch and of innovative restaurant franchising to further illustrate and underline the relevance of our results.     

Contract type and decision right of sales promotion in supply chain management with a capital constrained retailer

From the practices of Chinese consumer electronics market, we find there are two key issues in supply chain management: The first issue is the contract type of either wholesale price contracts or consignment contracts with revenue sharing, and the second issue is the decision right of sales promotion (such as advertising, on-site shopping assistance, rebates, and post-sales service) owned by either manufacturers or retailers. We model a supply chain with one manufacturer and one retailer who has limited capital and faces deterministic demand depending on retail price and sales promotion. The two issues interact with each other. We show that only the combination (called as chain business mode) of a consignment contract with the manufacturer’s right of sales promotion or a wholesale price contract with the retailer’s right of sales promotion is better for both members. Moreover, the latter chain business mode is realized only when the retailer has more power in the chain and has enough capital, otherwise the former one is realized. But which one is preferred by customers? We find that the former is preferred by customers who mainly enjoy low price, while the latter is preferred by those who enjoy high sales promotion level.     

Trade credit for supply chain coordination

Trade-credit is a seller’s short-term loan to the buyer, allowing the buyer to delay payment of an invoice. It has been the largest source of working capital for a majority of business-to-business firms in the United States. Numerous theories have been proposed to explain trade-credit, mainly from finance perspectives. It has also been an important issue in supply chain management. Surprisingly, most literature in supply chain management has examined the retailer’s stocking policies given a supplier’s trade-credit. This paper attempts to shed light on trade-credit from a supplier’s perspective, and presents it as a tool for supply chain coordination. Specifically, we explicitly assume firms’ financial needs for inventory. Following a Newsvendor framework, we assume that the supplier grants trade-credit and markdown allowance. Given the supplier’s offer, the retailer determines order quantity and the financing option for the inventory, either trade-credit or direct financing from a financial institution. Our result shows that the supplier’s markdown allowance alone cannot fully coordinate the supply chain if the retailer employs direct financing. Positive financing costs call for trade-credit in order to subsidize the retailer’s costs of inventory financing. Using trade-credit in addition to markdown allowance, the supplier fully coordinates the retailer’s decisions for the largest joint profit, and extracts a greater portion of the maximized joint profit.     

Consignment contracts with retail competition

Consignment contracts have been widely employed in many industries. Under such contracts, items are sold at a retailer’s but the supplier retains the full ownership of the inventory until purchased by consumers; the supplier collects payment from the retailer based on actual units sold. We investigate how competition among retailers influences the supply chain decisions and profits under different consignment arrangements, namely a consignment price contract and a consignment contract with revenue share. First, we investigate how these two consignment contracts and a price only contract compare from the perspective of each supply chain partner. We find that the retailers benefit more from a consignment price contract than from a consignment contract with revenue share or a price only contract, regardless of the level of retailer differentiation. The supplier’s most beneficial contact, however, critically depends upon the level of retailer differentiation: a consignment contract with revenue share is preferable for the supplier if retailer differentiation is strong; otherwise a consignment price contract is preferable. Second, we study how retailer differentiation affects the profits of all supply chain partners. We find that less retailer differentiation improves the supplier’s profit for both types of consignment contract. Moreover, less retailer differentiation improves profits of the retailers in a consignment price contract, but not necessarily in a consignment contract with revenue share.     

Contracting with asymmetric demand information in supply chains

We solve a buyback contract design problem for a supplier who is working with a retailer who possesses private information about the demand distribution. We model the retailer’s private information as a space of either discrete or continuous demand states so that only the retailer knows its demand state and the demand for the product is stochastically increasing in the state. We focus on contracts that are viable in practice, where the buyback price being strictly less than the wholesale price, which is itself strictly less than the retail price. We derive the optimal (for the supplier) buyback contract that allows for arbitrary allocation of profits to the retailer (subject to the retailer’s reservation profit requirements) and show that in the limit this contract leads to the first-best solution with the supplier keeping the entire channel’s profit (after the retailer’s reservation profit).     

A dynamic model for advertising and pricing competition between national and store brands

We study the relationship between the pricing and advertising decisions in a channel where a national brand is competing with a private label. We consider a differential game that incorporates the carryover effects of brand advertising over time for both the manufacturer and the retailer and we account for the complementary and competitive roles of advertising. Analysis of the obtained equilibrium Markov strategies shows that the relationship between advertising and pricing decisions in the channel depends mainly on the nature of the advertising effects. In particular, the manufacturer reacts to higher competitive retailer’s advertising levels by offering price concessions and limiting his advertising expenditures. The retailer’s optimal reaction to competitive advertising effects in the channel depends on two factors: (1) the price competition level between the store and the national brands and (2) the strength of the competitive advertising effects. For example, in case of intense price competition between the two brands combined with a strong manufacturer’s competitive advertising effect, the retailer should lower both the store and the national brands’ prices as a reaction to higher manufacturer’s advertising levels. For the retailer, the main advantage from boosting his competitive advertising investments seems to be driven by increased revenues from the private label. The retailer should however limit his investments in advertising if the latter generates considerable competitive effects on the national brand’s sales.     

Channel incentives in sharing new product demand information and robust contracts

Demand for a new product is often highly uncertain. As the developer of a new product, the manufacturer may reduce the uncertainty of the product’s demand through observing progress in his product development process or receiving demand signals directly from customers. This paper first shows that a centralized channel always benefits from improved demand information. Yet, to realize this benefit in a decentralized manufacturer–retailer channel, the manufacturer needs to disclose his private demand information to the retailer. We show that the manufacturer’s incentive to share his improved demand information depends on the supply contract signed with the retailer. Furthermore, mandating the manufacturer to disclose his improved demand information can actually reduce the total channel profit. We provide managerial insights by analyzing three widely used contract forms. We investigate whether these contracts are robust under an unanticipated demand information update observed by the manufacturer. We show that the quantity flexibility contract with a high return rate is not robust. The buyback contract, however, is robust and always achieves information sharing while preserving channel performance.     

Quality improvement vs. advertising support: Which strategy works better for a manufacturer?

We consider a marketing channel with a single manufacturer and a single retailer, where both advertising and quality improvement contribute to the build-up of goodwill. In a non-coop scenario, the retailer controls the advertising efforts while the manufacturer controls the quality improvements and wholesale price. Although improving quality positively contributes to goodwill, it also increases the production cost, thereby reducing the manufacturer’s profit. In a coop scenario, the manufacturer supports the retailer’s advertising while decreasing his investments in quality. We investigate the conditions under which a coop program is beneficial when such a trade-off occurs. Our results demonstrate that only when advertising significantly contributes to goodwill the manufacturer has an incentive to cooperate and a coop program turns out to be Pareto-improving. Conversely, the retailer is always better off with a coop program. Moreover, the channel is operational- and marketing-driven when quality effectiveness is high independent of advertising effectiveness or when both quality and advertising effectiveness are large. In all other cases, the channel is marketing-driven.