Practical and effective contracts for the dominant retailer of a newsvendor product with price-sensitive demand

Abstract

Abstract A manufacturer supplies a newsvendor product to a dominant retailer, who does not know the manufacturer's unit production cost k . The expected retail demand is a function of the unit retail price p . For this increasingly prevalent but rarely analyzed scenario, we compare the performance of several promising contract formats, including two new contract formats designed explicitly for a dominant retailer to implement, namely: (i) a retailer-implemented two-part tariffs where the retailer charges an upfront lump sum fee besides a fixed percentage markup over any given unit wholesale price, and (ii) a retailer-implemented volume discount scheme. We show that these two new formats perform substantially better than the currently-used practical formats. Thus, they form a basis for a dominant retailer to design a practical and effective purchase contract that approaches the power of the theoretically-optimal but impractical “menu of contracts.”