Multiperiod channel coordination in franchise networks: The necessity of internal inventory trading and franchiser involvement

Abstract

Facing consumers' growing demand for fast order fulfillment, it is important yet challenging for franchise companies to best incentivize frequent inventory sharing among their independent franchise retailers or dealers to achieve channel coordination. Past literature has only addressed such channel coordination for one‐time inventory sharing using contractual agreements, which unfortunately do not work for frequent inventory sharing. In this study, we consider multiple inventory‐sharing opportunities and propose a novel coordinating mechanism: internal inventory trading, enabled by disruptive IT platforms, such as the OneView platform's Inventory Management module (OVIM). On the OVIM, designed and operated by a brand (franchiser), every retailer (franchisee) can frequently access to all brand inventories virtually as they trade (buy or sell) inventory with one another and the brand. Using dynamic multiperiod games, we investigate how the brand should craft the trade rules and how the retailers should respond and trade periodically in equilibrium. We prove that channel coordination can be achieved in equilibrium, and the coordination requires both an internal inventory‐trading platform and the brand's proactive involvement in trading as the rule and market maker. Specifically, the coordinating trade rules require the brand to (1) only profit from the royalties (not from trading), (2) set the coordinating trade prices (CTPs) to respond to the real‐time channel inventory, and (3) let the buyer and the seller split shipping costs in any proportion, but not offering any subsidy. We provide a detailed characterization of the CTPs for each period, serving multiple purposes beyond simply removing double marginalization. When the channel inventory is high and imbalanced, the CTPs must include a trading reward to prevent retailers from strategically holding more or less inventory than the channel‐optimal amount to “manipulate” future trade prices. The good news is that these CTPs are intuitive (constant or market‐clearing) and can be automated into the trading platform ex ante. These actionable insights can guide franchise companies toward best utilizing their channel inventory and improving their profit and customer satisfaction.