Dynamic Decision-Making in a Decentralized Price-Setting Supply Chain

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In this paper, we study a decentralized supply chain in which the manufacturer sells a short lifecycle product using wholesale price (only) contracts to a price-setting retailer, who in turn sells it to the market. Our two-period framework captures the salient features of this product: Price-sensitive stochastic retail demand; non-stationary demand and cost parameters; correlated demands which enable updating of demand characteristics; and limited, but possibly more than one, pricing, replenishment and wholesale pricing (contracting) opportunities. First, we develop a benchmark model where the integrated chain can price and order at the beginning of each period. We then model four decentralized decision-making paradigms with increasing degrees of decision flexibilities: Neither pricing nor ordering recourse; only pricing recourse; pricing and ordering recourses; and finally, pricing, ordering and contracting recourses. A novel transformation technique allows us to analytically characterize all the five models, and reduce the complex profit maximization problems in each case to a mere one-dimensional search. Subsequently, based on a numerical study, we systematically compare the values and behaviors of the optimal decisions for the five models. In addition, we offer managerial insights as to how optimal decisions behave temporally and how they are affected by system characteristics like price elasticity, demand correlation and demand uncertainty. A more detailed investigation comparing the optimal profits for the five models allows us to identify the values of pricing, ordering and contracting flexibilities from the viewpoint of the two channel partners. Our analysis generates managerial suggestions as to which decision-making paradigm might be most suitable for the chain depending on the business environment and on the lifecycle phase of the product.

, 46 pages


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