Coordination in a distribution channel with decisions on the nature of incentives and share-dependency on pricing

Abstract

We research the most suitable coordination mechanism for a distribution channel that is composed of one manufacturer and one retailer. Coordination is sought through a Revenue Sharing Contract (RSC) and the channel members have four coordination options in the menu: The share of revenues can be either set during the course of the game (endogenous) or preset before the game starts (exogenous); similarly, the retail price can be either share-dependent or share-independent. We seek to identify the coordination mechanism that leads to a profit-Pareto-improving situation with respect to a non-coordinated channel that implements a wholesale price contract. We compare players’ profits in the four coordination options and identify the mechanisms that firms prefer. Compared to the non-coordinated channel, our findings suggest that the manufacturer is always economically better-off through coordination, independent of the mechanism the channel uses. In contrast, the retailer is better-off with a share-dependent-pricing mechanism with the share set ex-post. The adoption of a preset share is conditionally beneficial to the parameter fraction. The economic value loss due to the double marginalization cannot be entirely eliminated, independent of the nature (exogenous or endogenous) of the sharing parameter and on the effect of RSC on pricing. In the comparison among coordination mechanisms, only a share-dependent-pricing mechanism with the share fixed over the course of the game is profit-Pareto-improving.

Keywords:

• marketing channel
• incentive
• coordination
• pricing
• Revenue Sharing Contract

Notes

1 This result is due to the leader-follower structure of the game while it might differ in the coordination games according to how the total profits in the vertically integrated channel are shared between the two channel members.

2 To clarify the sign of this derivative, a numerical illustration has been developed as follows: • φ=0.1, p^II−ω^II=0.9969;• φ=0.5, p^II−ω^II=1.4515;• φ=0.9, p^II−ω^II=1.5166.Section 3 reports the baseline parameter values used in this numerical illustration.

3 To clarify this statement, three cases are provided as an example:• φ=0.1, the term in the squared brackets is βμ +(1−2*0.1(2−0.1)) (βμ−θ²)=βμ+0.62(βμ−θ²)>0;• φ=0.5, the term in the squared brackets is βμ+(1−2*0.5(2−0.5)) (βμ−θ²)=βμ−0.5(βμ−θ²) =0.5βμ+θ²>0; • φ=0.9, the term in the squared brackets is βμ−0.8(βμ−θ²) =0.2βμ +0.8θ²>0.

4 Further simulations on the parameter values can be provided upon request. The simulation analysis is not presented in this paper because it does not supply a significant contribution to identify the most suitable RSC package.