Is channel coordination all it is cracked up to be?

Abstract

A fundamental task for supply-chain managers is to determine wholesale-prices. Such determination is a core theme in the marketing science literature on distribution channels—which seems to have concluded that channel coordination—setting wholesale-prices to maximize total channel profit—represents the best of all possible objectives. This judgment is based on analyses of bilateral monopoly models, within which profit may be redistributed to the benefit of all channel members. However, many manufacturers deal with multiple, competing retailers. The pure logic of bilateral monopoly models holds in the presence of multiple retailers if and only if the manufacturer can price discriminate between retailers. Although mechanisms for price discrimination exist, in many situations they are infeasible, illegal, or both. When retailers compete there are two feasible and legally permissible methods of achieving channel coordination: an explicit quantity-discount schedule or a menu of two-part tariffs. (The latter is derived in detail in this paper.) A feasible and legally permissible alternative to channel coordination is for the manufacturer to utilize a sophisticated Stackelberg two-part tariff—itself a form of a quantity-discount schedule. Although such a tariff cannot coordinate the channel, it is the best of all possible two-part tariffs from the viewpoint of maximizing manufacturer profit. Because manufacturers are ultimately interested in their own profitability, it follows that channel coordination is manufacturer-optimal only if it generates at least as great a level of profit for the manufacturer as does noncoordination. In this paper we determine the conditions under which a channel-coordinating wholesale-price strategy will manufacturer-profit dominate a sophisticated Stackelberg two-part tariff. We show that the optimal policy is dependent on (1) the retailers’ fixed costs, (2) the relative size of the retailers, and (3) the degree of inter-retailer competition. We conclude that, from the perspective of a manufacturer, channel coordination is often undesirable relative to utilizing a noncoordinating, sophisticated Stackelberg price-strategy. Therefore, channel coordination can no longer be regarded as the ultimate goal which supply-chain managers should uncritically pursue.