A feasible incentive contract between a manufacturer and his fairness-sensitive retailer engaged in strategic marketing efforts

Abstract

This paper considers a feasible incentive contract between a manufacturer and a fairness-sensitive retailer. The manufacturer (he) dominates the supply chain and determines his wholesale price, while the retailer (she) focuses on marketing and retailing. Thus, the retailer’s decision concerns her marketing efforts and retail price. The market demand is linked directly to the retailer’s marketing efforts and retail price. Therefore, we find that the retailer’s fairness preference leads her to engage in high-level marketing efforts, but causes the manufacturer to set a low wholesale price. A strategic decision-making approach that the manufacturer can employ is to consider the retailer’s fairness sensitivity. We also find that the retailer’s concern for fairness influences the manufacturer’s decisions strongly and affects his expected profit negatively. The manufacturer dominates the supply chain, thereby motivating him to design a feasible incentive contract to maximize his expected profit. Thus, a fairness-embedded profit-sharing contract applied with a Nash bargaining process is proposed to maximize the manufacturer’s expected profit. Both mathematical derivations and numerical studies show that the incentive contract leads to Pareto improvement in the utilities of the manufacturer and the retailer.