Power structure and profitability in a three-echelon supply chain facing stochastic demand

Abstract

In this paper, we investigate how the order in which supply chain members demand their respective margins, which is often called power structure, influences their profitability in a three-echelon supply chain facing stochastic demand. We consider a typical three-echelon supply chain consisting of an upstream firm, a midstream firm, and a downstream firm. Previous supply chain models examining power structure have shown the conventional result that a supply chain member that sets a price or margin earlier generates a higher profit in a deterministic environment; that is, firms achieve higher profits in the order of the first-mover, the second-mover, and the third-mover who set margins in a three-echelon chain. Here, the first-mover, second-mover, and third-mover mean the supply chain member who sets its margin first, second, and third, respectively. Our stochastic model suggests the starkly contrasting result that the expected profit under demand uncertainty is higher in the order: (i) in a wide range of circumstances, the third-mover, the first-mover, and the second-mover who demand margins or (ii) in a narrower range of circumstances, the third-mover, the second-mover, and the first-mover. That is, the range of exogenous parameters leading to the first case is broader than that leading to the second case. The result indicates that the first-mover advantage is completely lost and, instead, the last-mover advantage always arises in a stochastic environment. Currently, power in supply chains tends to shift from upstream firms to downstream firms. However, our results warn a supply chain member in a stochastic environment that if assuming leadership to set its price or margin just because it has the power to do so, the member can ultimately harm itself and reduce its own profit.