Coordination in a retailer‐dominated supply chain with a risk‐averse manufacturer under marketing dependency

• Author: Qian Lei,Juan He,Fuyou Huang
• Date: 01 November 2020
• Published date: 01 November 2020
• DOI: http://doi.org/10.1111/itor.12520

Intl. Trans. in Op. Res. 27 (2020) 3056–3078

DOI: 10.1111/itor.12520

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Coordination in a retailer-dominated supply chain with

a risk-averse manufacturer under marketing dependency

Fuyou Huang,∗, Juan He and Qian Lei

School of Transportation and Logistics, SouthwestJiaotong University, Chengdu 610036, P.R. China

E-mail: fuyou.huang@hotmail.com [Huang]; hejunlin93@163.com [He]; leiqian900219@163.com [Lei]

Received 29 March 2017; receivedin revised form 29 October 2017; accepted 20 January 2018

Abstract

In this paper,a combined contract composed of option and cost sharing is proposed to investigatecoordination

and risk-sharing issues of the supply chain consisting of a dominant retailer and a risk-averse manufacturer.

Demand faced by the retailer is stochastic in nature and dependent on marketing effort. We adopt the

conditional value-at-risk (CVaR)criterion to model risk aversion of the manufacturer, and derive the optimal

strategy for each member with a Stackelberg game in which the retailer acts as the leader.It is verified that the

combined contract can coordinatethe supply chain and achieve Pareto-improvement.Moreover, the dominant

retailer can allocate the system-wide profit arbitrarily only by option price in the premise of coordination. It

is worth mentioning that coordination of the supply chain is reachable only when the manufacturer is low

in risk aversion, and the manufacturer’s risk aversion is a significant element for contract design and profit

allocation.

Keywords:supply chain coordination; dominant retailer; option contract; CVaR; marketing dependency

1. Introduction

Since entering the postindustrial age,relationships between manufacturers and retailers in the supply

chain have dramatically changed. The retailing industry today is increasingly dominated by large,

centrally managed “power retailers” (Raju and Zhang, 2005), such as Wal-Mart, Tesco, Home

Depot, and Best Buy. This trend has been attributed to the increased use of information technology

by retailers, increased concentration of the retailing industry, channel restructuring, advertisement

and retail management, and so on (Geylani et al., 2007). “Dominant” means that retailers have

the power of controlling or influencing other members’ decisions, such as production and delivery

decisions of their suppliers (Hua and Li, 2008; Lau et al., 2008).

Due to uncertain market demand and strong competition, retailers always prefer to order flexibly

with a low wholesale price from manufacturers, some of them squeeze manufacturers by setting an

∗Corresponding author.

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F. Huang et al. / Intl. Trans.in Op. Res. 27 (2020) 3056–3078 3057

even lower wholesale price to gain greater profit. Because retailers control the channel, manufac-

turers need to sacrifice some profits in exchange for market share. However, no manufacturers can

tolerate the squeeze in the long run, and the cooperation is quite unstable (Wang and Liu, 2007).

Retailers realize thatthe profit across the supply chain can be improved throughgreater cooperation

and better coordination. Option contract is a viable alternative and increasingly popular to obtain

an efficient supply chain, which can help retailers ensure supply and pricing to meet uncertain

future demand, and also provide the flexibility on the quantity of product to purchase when future

demand information is available (Wu and Kleindorfer, 2005; Chen et al., 2014). In fact, option

contracts have been widely adopted in various industries such as retailing (Wang and Liu, 2007),

toys (Barnes-Schuster et al., 2002), IT (Nagali et al., 2008), and communications (Chen and Shen,

2012).

Most of the existing literature on channel coordination with option contract focus on the

manufacturer-dominated supply chain, where manufacturers design option contracts (Burnetas

and Ritchken, 2005; Mart´

ınez-de-Alb´

eniz and Simchi-Levi, 2005; Xu, 2010; Zhao et al., 2013; Liu

et al., 2016), and few studies consider coordination issues of supply chain with option contract in

dominant retailer context. Based on Cachon and Lariviere (2001), Wang and Liu (2007) explored

channel coordination and risk sharing in a retailer-led supply chain under option contract, and

proved thata successful coordination is reachable. The dominant retailer can not onlyorder flexibly

but also transfer inventory risk by the option contract employed in their models. Nevertheless,

they did not take decision maker’s risk preference into consideration. In practice, manufacturers

usually are risk-averse in retailer-dominated supply chain because of strong competition, “less

power,” and uncertain demand. The behavior of manufacturers affects their production decisions

and even supply chain performance. It is significant to investigate the effect of the manufacturer’s

risk aversion on supplychain decision making. Thus, based on Wang and Liu (2007), we extend the

option models to a more general supply chain with risk aversion and marketing effort in this paper.

Cai et al. (2016) proposed such an option contract for a two-echelon supply chain operating un-

der vendor-managed inventory, and find that supply chain coordination and Pareto-improvement

can be achieved synchronously. However, they also engaged in coordination problems based on

the assumption of risk neutrality. Zhao et al. (2010) considered the coordination issue with a co-

operative game approach by option contract, where the retailer determined an optimal reserved

quantity and the manufacturer determined an optimal production quantity under the option con-

tract, respectively. They discussed scenarios in which option contracts are selected according to

individual supply chain members’ risk preferences. Different from Zhao et al. (2010), in this paper

we model risk aversion of the manufacturer by the CVaR criterion, and take marketing effort into

account.

Usually, decision makers are supposed to be risk neutral and to maximize the expected profit

or minimize the expected cost in most supply chain models (Chen et al., 2014). But supply chains

nowadays become more vulnerable to uncertainty, decision makers focus on risk or potential loss

besides the expected profit. The assumption of risk neutrality is inadequate for contemporary

supply chain management. The phenomenon is confirmed by a series of experimental studies and

observations of managerial decision making under uncertainty (Schweitzer et al., 2000; Ho and

Zhang, 2008; Feng et al., 2011). Utility functions (Chen et al., 2007), mean variance (Wei and Choi,

2010), and VaR/CVaR are the three main research streams of modeling enterprises’ risk aversion

in recent years. The strengths and limitations of the three main means have been discussed in the

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2018 The Authors.

International Transactionsin Operational Research C

2018 International Federation of OperationalResearch Societies