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Article Excerpt
1. Introduction
In the context of supply contract design, the common wisdom is that the party holding the leadership realizes the greater profit. Traditionally, the supplier (e.g., manufacturer) has been more powerful, and. hence, the existing literature in the area emphasizes supplier-driven contracts in which the supplier acts as the channel leader. In fact, suppliers in monopolistic markets are able to charge above-competitive prices and, thereby, easily establish supplier-driven channels. However, in some markets, such as the B2B grocery channel, the market power has shifted to the buyer (e.g., retailer) (see Foer (2000) and Ertek and Griffin (2002)). In the United States, large retailers such as Walmart, the second-largest company in the world (The Apex Group, 2006). exert tremendous market power over their suppliers. Thus far, however, only a limited number of research papers have analyzed this shift in the power structure.
Our paper considers the bilateral monopoly setting that has been analyzed previously from the supplier's perspective (Corbett and Tang, 1999; Corbett and De Groote, 2000; Ha, 2001; Corbett et al, 2004). We focus, however, on the case where the buyer has the dominant power and establishes a buyer-driven channel by assuming the leadership and offering the terms of the contract. In this context, the bilateral monopoly setting is, in fact, of practical importance. Using Wal-Mart as an example, it is clear that any major cosmetics brand name targeting budget-conscious customers, such as Revlon, Maybelline, Cover Girl, etc., would be interested in one-on-one negotiations with the price-cutting retailer and vice versa. The list of examples can be extended by including the market shares of the few retail giants for brand name household items from personal hygiene products to small electric appliances. This is due to increased consolidation at the retail level; larger retailers have greater bargaining influence over their suppliers (Messinger and Narasimhan, 1995). In fact, consolidation in grocery retailing has been a powerful trend in recent years. In 2007, the total supermarket sales in the US is estimated as $535.4 billion (Food Marketing Institute, 2007a) and the share of the top five chains accounts for 54% (Food Marketing Institute, 2007b). As a natural consequence of these trends, buyer-driven channels have become more prevalent, and the underlying supply contract problems addressed in this paper are increasingly important.
Contract flexibility is critical for the powerful party to gain benefits from exerting marketing power in contracting by assuming the leadership position. The three general types of contracts, i.e., one-part linear schemes, two-part linear schemes and two-part non-linear schemes, that have been studied in the context of supplier-driven channels are still applicable in the context of buyer-driven channels. In the ACNielsen's 2000 Annual Survey of Trade Promotion Practices (ACNielsen, 2000), 85% of the retailers report charging slotting fees whereas 42% of the manufacturers report that they are charged increased slotting allowances. Klein and Wright (2007) report that total trade promotion spending, including slotting, constitutes 13-17% of manufacturer gross dollar sales. It is estimated that approximately 11% of trade dollars are spent on slotting fees by the manufacturers (Wilkie et al, 2002). As a general practice, powerful retailers are seeking to provide more general contracts, and slotting fees are identified as a mechanism through which their market power is exercised (Dimitri, 2001). In order to investigate the impact of these practices, this paper first examines the impact of leadership structure under the one-part linear scheme and then under the more general schemes involving slotting fees, i.e., two-part linear and non-linear schemes.
Despite recent advances in information technology and the trend towards sharing information among supply chain partners, information asymmetry remains a key feature of real supply chain relationships. For this reason, we investigate a total of six scenarios for the buyer-driven channel: three general contracts, each under full and incomplete information about the supplier's cost structure. We develop the counterpart buyer-driven models which complement the supplier-driven models studied in Corbett and Tang (1999) and Corbett et al. (2004), and derive the buyer's optimal contracts and profits for the three different contract types. Our main focus is on the impact of leadership shifting in the channel. To this end, building upon the results in Corbett and Tang (1999) and Corbett et al. (2004), we attempt to answer the following questions.
1. Is leadership as beneficial as it is believed to be?
2. From the system's perspective, which leadership structure is better under different contracts?
3. What is the value of leadership under different contract types and information structures?
Our analysis leads to several interesting observations. First, a shift of leadership from the supplier to the buyer improves the system efficiency under a one-part linear contract when the buyer has full information. Second, in the case of full information, the leadership is beneficial for the lead in both supplier and buyer-driven channels and the value of the leadership in both channels is higher under the more general contract type. Third, when accurate information is not available, leadership is not necessarily beneficial for either party and that this tenet of common wisdom does not hold, i.e., it is not always wise for the buyer or the supplier to pursue the leadership under information asymmetry. Finally, the more general types of contracts may not increase the value of holding the leadership when information asymmetry exists, and further, the party without accurate information does not necessarily benefit from the leadership even when a two-part non-linear contract is allowed. Our findings indicate that sometimes one party can forfeit the leadership and retain a higher profit.
The remainder of this paper is organized as follows. In Section 2, we provide a brief review of pertinent literature. Section 3 introduces the modeling framework. The buyer's optimal contracts are analyzed in Section 4. The impacts of leadership structure, contract type and information asymmetry on channel performance are explored in Section 5. Our numerical results regarding the impacts of various model parameters are in Section 6. Finally, Section 7 offers conclusions and a future research direction.
2. Related literature
The volume of work on supply chain coordination and contracts in the economics and operations management (OM) literatures is enormous (Tirole, 1988; Tsay et al., 1999; Cachon, 2003; Fugate et al., 2006; Nagarajan and Sosic, 2008). However, despite the practical trends leading to more prevalent buyer-driven channels, thus far, only a limited number of papers have addressed this shift in the leadership structure (Lau et al, 2008).
A closer examination of the existing literature reveals that the previous work examining buyer-driven channels flow into two streams. One stream concentrates on the impact of allocation of decision rights and inventory risk allocation, rather than the impact of leadership directly, e.g., Wang and Gerchak (2003), Cachon (2004) and Gerchak and Wang (2004). That is, for the purpose of investigating the impact of inventory risk allocation between the two parties, this stream of work studies the supplier and buyer-lead channels where the leader specifies the wholesale price and the follower bears the inventory risk. Although one can argue that the accompanying results demonstrate the benefit of channel leadership, they only do so under the assumption that the leader has the liberty of choosing the wholesale price and avoiding the inventory risk.
The second stream of work on buyer-driven channels examines the impact of buyers leadership without changing the traditional decision rights of the two parties involved (Choi, 1991; Ertek and Griffin, 2002; Cachon and Zhang, 2006; Lau, Lau and Wang, 2007; Lau et al., 2008). Our work also falls within the second stream because we examine the case where the supplier makes the wholesale price decisions and the buyer makes the market price decisions. Through a careful analysis of the complementary contract types for supplier and buyer-driven channels without switching the decision rights, we argue that the leader (buyer or supplier) is able to extract the maximal system's profit under full information. However, private information usually exists in a supply chain, and it is often associated with leadership. Therefore, information asymmetry must be considered explicitly. There are two main types of information asymmetry concerns addressed in the OM literature: demand information (Cachon and Fisher, 2000; Cachon and Lariviere, 2001; Lau and Lau, 2005; Lau, Lau and Zhou, 2007; Arcelus et al., 2008) and cost information (Corbett and Tang, 1999; Corbett and De Groote, 2000; Ha, 2001; Cachon and Zhang, 2006; Sucky, 2006; Lau, Lau and Wang, 2007; Gurnani and Erkoc, 2008; Lau et al., 2008). Our interest in this paper pertains to the latter concern in the context of buyer-driven channels, as in (Cachon and Zhang, 2006; Lau, Lau and Wang, 2007; Lau et al, 2008), rather than supplier-driven channels (Corbett and Tang, 1999; Corbett and De Groote, 2000; Ha, 2001; Sucky, 2006).
Assuming that the buyer is the leader of the channel, Cachon and Zhang (2006) study a queueing model where the buyer has incomplete information about the suppliers' costs and has to choose a supplier. A sophisticated procurement mechanism is identified to minimize the buyer's total cost. When compared with simpler mechanisms, such as charging a late fee and specifying a fixed lead time requirement, the more sophisticated mechanism is not very beneficial. This is due to the supplier's advantage associated with private cost information. Lau, Lau and Wang (2007) examine how a dominant retailer should operate under a deterministic demand curve when his knowledge of the manufacturer's cost is imperfect. An optimal markup is derived and a quantity discount scheme is proposed where a discount...
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