uniform vs. retailer-specific pricing: incentive alignment to enhance supply chain efficiency

June, 2015

Paper’s summary

Uniform vs. Retailer-Specific Pricing: Incentive Alignment to Enhance Supply Chain Efficiency

Based on the paper “Vakharia, A., Wang, L., 2014, Uniform vs. Retailer-Specific Pricing: Incentive Alignment to Enhance Supply Chain Efficiency, POM 23(7), pp. 1176-1182

Leonardo Laranjeira GomesPhD StudentMIT-Zaragoza International Logistics ProgramZaragoza Logistics Center

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Overview: comparison of UWP and RSWP and proposition of a coord. contract combining UWP and slotting allowance and/or side payment

Overview• The setting: one supplier selling to multiple, cost-asymmetric, retailers.• Two wholesale pricing strategies:

• Uniform wholesale price (UWP); and• Retailer-specific wholesale price (RSWP).

• In a myopic and uncoordinated setting:• The less efficient retailer and the supplier prefers RSWP; while• The more efficient retailer prefers UWP.

• However, as UWP leads to superior profits for the whole system:• The authors proposed a coordinating contract using a combination of UWP and slotting

allowance and/or side payment. • Through the specification of its parameters, the contract scheme proposed allows the supplier

to exert some control of the profit splitting among the retailers

Source: Vakharia and Wang 2014

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Contents

1. Introduction

2. The model

3. RSWP vs. UWP and Total Supply Chain Profits

4. Conclusions

5. Extension

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Contents

1. Introduction

2. The model


4. Conclusions

5. Extension

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The setting: pricing scheme decision for a supplier selling a single product to non-competing retailers, which are equally sized and cost-asymmetric

• The supplier: single product.• The retailers:

• Non-competing;• Equally sized; and• Asymmetric regarding cost-efficiency.

• The retailer decides whether to sell under a UWP or a RSWP pricing scheme.• Retailers have their own preferences regarding the pricing scheme.• Retailers are allowed to set their market prices• Research question: “how the choice of the wholesale pricing scheme impacts not only the supplier

and individual retailer profits but also the profits of the entire supply chain?”


Note on cost asymmetries: different levels of operating economies are due to several factors, such as transportation costs and business processes.

Note on RSWP’s legality in some countries: by assuming that retailers are not in direct competition with one another, no anti-competitive impact is present in the model.

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Previous literature consider uniform market prices and prioritizes consumer welfare. It has been showed that RSWP can achieve coord’n.


Literature review on RSWP and UWP

Author(s) Year(s) Field General Idea

KatzDeGrapaYoshida

198719902000

Economics

Compares RSWP and UWP; however:• DeGrapa and Katz consider identical market

prices at the retailers.• Consumer welfare as a major concern (the

quantity available to the final consumer).

Berenstein and Federgruen

2004 and 2005

SC coordination

RSWP can achieve coordination under demand uncertainty, with or without competition, if each retailer adopts a baseline stock policy and/or by contractual arrangements

Vakharia and Wang allow retailers to determine market prices, and are concerned about total supply chain profits. They show that UWP leads to greater supply chain efficiency

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Yet, as the supplier would prefer UWP, the authors propose a contract scheme combining UWP with a slotting allowance and/or side payment


Slotting allowances and fees

• Represent a significant cost to grocery manufacturers and two schools of though dominate its controversial debate (Bloom et al., 2000):

• One views them as a tool for improving channel efficiency through cost and risk sharing; and• The other considers them as a tool for enhancing market power and damaging competition.

A slotting allowance is a payment from the supplier to the retailer. On the other hand, a side payment, is a payment collected by the supplier from the retailer

“Slotting allowances and slotting fees describe a family of marketing practices that involve payments by manufacturers to persuade downstream channel members to stock, display, and support new products” (Bloom et al., 2000)

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Contents

1. Introduction

2. The model


4. Conclusions

5. Extension

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The model approach involves a supplier and two retailers


• One supplier offering a single product, with marginal cost z.

• Two retailers i, i=1,2- Asymmetric, w/ cost efficiencies ci

• Order quantities, qi, depend on the wholesale

price vi, which is determined by the supplier.

• Demand qi(pi) is a strictly non-decreasing

function of the consumer price pi, which is stated by the retailer.- qi(pi)=A-Bpi, where A is the market potential

and B is the price elasticity of demand.- The parameters related to market size are

constant across retailers.

The processThe model setup

1. The supplier offers a wholesale price vi to each retailer;

2. Each retailer makes its own decision on the order quantity qi, simultaneously defining the market price pi; and

3. The final profits of each party in the supply chain are determined.

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Notation summary


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Supplier’s incentive-compatible profit maximization under RSWP:

Supplier’s incentive-compatible profit maximization under UWP:

For each retailer i, given a wholesale price vi, the optimization problem is to maximize the profit function


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Letting retailer 2 be the most efficient (i.e. c1>c2), the first analysis was conducted by comparing prices, quantities, and profits


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Under RSWP, the more efficient retailer is penalized


Under RSWP, the more efficient retailer is charged a higher wholesale price (i.e. v2>v1). Therefore, the supplier is in a position to extract a higher “rent” from the more efficient retailer, as compared to the less efficient.

Additionally, the optimal wholesale price under UWP is bounded such that v2>v >v ̃� 1.

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RSWP is a preferred scheme if the retailers differ in their efficiencies


The supplier profits are larger when it adopts the RSWP scheme as compared to the UWP (i.e. ϕ>ϕ˜ ).

However, if c1=c2, UWP is preferred

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The less efficient retailer prefers RSWP, while the more efficient retailer prefers UWP


The comparative impact in the retailers profits and order quantities are: under RSWP, the less (more) efficient retailer makes larger (smaller) profits and orders more (less) as compared to UWP

RSWP penalizes the more efficient and rewards the less efficient. The UWP scheme would alleviate this risk by sending a signal of “fairness”, but the retailer would make less profits.

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Contents

1. Introduction

2. The model


4. Conclusions

5. Extension

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Authors also included Integrated Supply Chain (ISP) profits, which are independent of the wholesale pricing scheme.

Next step: examining total supply chain profits for each pricing scheme. Integrated Supply Chain (ISP) were also included, as a reference


Intuition: the more efficient retailer tends to charge lower market prices under the UWP and this tends to increase the market coverage for this retailer, compen

• The difference between UWP and RSWP demonstrates that the former dominates the latter from a total SC profits perspective.

• As the retailer asymmetry, c2-c1, increases:- The difference between the pricing schemes

also increases and UWP becomes even more preferable over RSWP; and

- The difference between ISP and UWP decreases, thus it increases the degree of coordination of UWP.

•

FindingsSupply Chain Profits

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These results lead to a contract that could be used by the supplier to ensure that his profits are greater under UWP than under RSWP


Contract optimal parameters:• Offer a UWP for both retailers of:

• For the less efficient retailer (retailer 1), provide a slotting allowance of:

• For the more efficient retailer (retailer 2), collect a side payment of:

Net effect for the supplier: profits are at least as large as under RSWP

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In addition, the parameters δ and ϵ allow the supplier to exert some control over the profit splits


Retailers’ profit functions under the proposed contract

• Profits for retailer 1 (the less efficient) are in the range [π ̃�1 ,π1].

• By defining δ, the supplier controls the profits for retailer 1. However, δ also influences the profits for retailer 2.

• If the supplier wants to ensure that the profits for retailer 2 are at least those obtained under the RSWP strategy, then the following must hold:

• If the supplier wants to simultaneously ensure that the minimum profits for retailer 1 is similar to UWP and for retailer 2 is similar to RSWP, then:

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Finally, the authors discuss whether it is possible to design a UWP contract that leads to all the parties obtaining the maximum profit


• This is not possible as the loss for the supplier adopting the UWP scheme is larger than the total gain in supply chain profits when using the UWP scheme as compared to the RSWP strategy:

• Therefore, if the supplier offers the UWP scheme, it requires the collection of a minimum side payment this would result in at least one of the retailers not realizing the maximum possible profits.

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Contents

1. Introduction

2. The model


4. Conclusions

5. Extension

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Conclusions

• The authors have investigated the impact of alternative wholesale pricing schemes on the supply chain profits.

• They were able to structurally characterize the respective impacts of UWP and RSWP.• The key findings are that if retailers are asymmetric with respect to cost-efficiency

then:• The supplier would always prefer RSWP to maximize its own profits;• The optimal UWP is always lower than the optimal RSWP to the more efficient

retailer;• The optimal UWP is always higher than the optimal RSWP to the less efficient

retailer; and• The more efficient retailer would prefer the UWP while the less efficient retailer

would prefer the RSWP.


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Suggestions of extensions (from the authors)

• To compare other pricing schemes (e.g. quantity discounts) in a similar setting• To investigate how market parameters (which is held constant across retailers in this

article) would impact and/or moderate some of the finding in this work.


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Contents

1. Introduction

2. The model


4. Conclusions

5. Extension

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Suggestions of extensions

• To employ a game theoretical approach in a similar setting, considering competing suppliers.

• To evaluate a similar setting with stochastic demand.


uniform vs. retailer-specific pricing: incentive alignment to enhance supply chain efficiency

Business

rswp pricing scheme

combination of uwp

comparison of uwp

retailerspecific pricing

retailers source

uniform wholesale price

efficient retailer

individual retailer