Impact of power structure on supply chain performance and consumer surplus

• DOI: http://doi.org/10.1111/itor.12466
• Author: Jian‐Cai Wang,Yao‐Yu Wang,Fujun Lai
• Date: 01 September 2019
• Published date: 01 September 2019

Intl. Trans. in Op. Res. 26 (2019) 1752–1785

DOI: 10.1111/itor.12466

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IN OPERATIONAL

RESEARCH

Impact of power structure on supply chain performance

and consumer surplus

Jian-Cai Wanga, Yao-Yu Wangb,∗and Fujun Laib

aSchool of Management and Economics, Beijing Institute of Technology, and Sustainable Development Research Institute

of Economy and Society of Beijing, Beijing, P.R. China

bResearch Center for SmarterSupply Chain, Dongwu Business School, Soochow University, Suzhou, Jiangsu, P.R. China

E-mail: wangjiancai@bit.edu.cn [Wang]; wangyaoyu@suda.edu.cn [Wang];fujun.lai@usm.edu [Lai]

Received 15 August 2016; received in revised form 30 August 2017; accepted 1 September 2017

Abstract

In this study, we consider a game theory based framework to model power in a supply chain with price-

dependent stochastic demand and to investigate how power structures (dominant retailer, dominant manu-

facturer, or balanced power) and demand models (expected demand and demand shock) affect supply chain

efficiency, members’ profits, and consumer surplus. We analyze all of the problems in this framework and

characterize their equilibrium outcomes. In comparison, we demonstrate that a firm often benefits from its

power except that a power manufacturer might suffer in a supply chain with isoelastic demand and additive

shock. A balanced power structure is often conducive to the whole supply chain, but this structure might

not perform very well in a supply chain with isoelastic demand and additive shock. Power structures and

demand models act on consumers in much the same manner that they do on supply chain efficiency. In other

words, consumers often prefer a balanced power structure and thereby do not profit from power retailers.

Additionally, we find that the retail price can play a pivotal role in determining supply chain efficiency and

consumer surplus. Specifically, the lower the retail price, the higher the supply chain efficiency and consumer

surplus. In contrast, the service level has a less preeminent influence on both of them.

Keywords:power structure; game theory; newsvendor; pricing

1. Introduction

Considerations of powerpermeate virtually every element of supply chains (or distributionchannels).

Due to the existence of power imbalances in almost every industry, supply chain coordination and

conflict issues have tended to be driven more by power and control rather than by mutual win-win

intentions. The purpose of this research is to theoretically investigatethe impact of power structures

on supply chain performance and consumer surplus.

∗Corresponding author.

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J.-C. Wang et al. / Intl. Trans. in Op. Res. 26 (2019) 1752–1785 1753

This paper is motivated by the observations that different power structures have appeared in

real-world supply chains. Traditionally, manufacturers such as Apple, Caterpillar, and designer

goods manufacturers have often been considered to be more powerful than their downstream firms

and to engage in some practices that might impose some restrictions on the channel partners. To

better manage consumer demand, to respond to competition, and to send the appropriate quality

signal, power manufacturers often attempt to influence the final prices of their products (Munson

et al., 1999). Some industry practices, such as “minimum (advertised) pricing” and “resale price

maintenance,” often demonstrate the power of manufacturers. For example, books, snacks, and

greeting cards have prices printed on them. Apple always announces the retail prices ofits products

before the introduction of them into the market. All of these practices can leave little flexibility

for retailers to provide discounts or to set their own prices, thus squeezing their profit margins.

In addition, power manufacturers can also influence (not dictate) downstream retailers’ decisions

through some mechanisms. For example, in a simple price-only contract, the power manufacturer

can first set the wholesale price but not the retail price,and the retailer decides the retail price based

on the wholesale price.

With the increasing prevalence of huge retail chains, such as Wal-Mart, Carrefour, and Tesco,

over the past two decades, downstream retailers have become more powerful and have started to

pursue a dominant strategy in some of their supply chain interactions. The rise of the market

power of these giant retailers has caused widespread public concern. For example,the media always

portrays Wal-Mart as a worldwide chain of exploitation, destroying communities while squeez-

ing its employees and suppliers alike (Huang et al., 2012). Its sheer size and power compelled

manufacturers to ask whether to “say no to Wal-Mart” (Bowman, 1997). The demise of Rubber-

maid is an often-cited example of retailers’ power. When the durable housewares producer, one of

America’s most reputable companies, attempted to pass on a cost-based price increase, Wal-Mart

pulled all of Rubbermaid products from its shelves in 1994. The big-box retailer was Rubbermaid’s

largest outlet, and the manufacturer could not recuperate and was forced to sell out to Newell

several years later. Now, more than 700 suppliers have built offices close to Wal-Mart company

headquarters in Bentonville, Arkansas, in an attempt to strengthen ties with the dominant chain.

Recently, Wal-Mart claimed that it was interested in doing business only with suppliers that share

their goals of sustainable operations (Rosenbloom, 2010). Although it is not a compulsory policy,

this declaration could have an indirect influence on the suppliers’ operations. Another example

is JD.com, a largest online shopping mall in China. JD.com made it clear that suppliers should

ensure a 20% gross profit margin for themselves to have their products sold on JD.com’s Website

(http://money.163.com/12/0210/03/7PSCTSCV00253B0H.html).

In contrast to the aforementioned power asymmetry examples, the supply chain members might

share equal power. A typical example is the partnership between Wal-Martand P&G, which work in

close cooperation (Jerath et al., 2007). As a counterexample, the Chengdu outlets of Gome (a giant

retailer of home appliances in China) cut the prices of Gree’s products significantly without prior

consent from Gree (a giant manufacturer of air conditioners) in 2004. Gree refused to compromise

and threatened to terminate supply. Finally, the event ended in a lose-lose game (Chowet al., 2011).

It is intuitively expected that a power agent’s performance might be enhanced by utilizing its

influence on strategies in the supply chain to shape or dictate other partners’ operating deci-

sions, such as pricing and stocking. Is this always the case? If not, under what condition might

the power agent benefit from its power? How would the dominated agent fare when it faces the

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vertical restrictions imposed by the dominant agent in the supply chain? How does the power

structure influence supply chain efficiency (i.e., the total supply chain profit)? Do consumers profit

from the emergence of a power firm in a distribution channel, especially a power retailer such

as Wal-Mart? These questions relate to the impact of different power structures on channel per-

formance and consumer surplus. While the supply chain modeling literature has extensively ana-

lyzed agents’ independent decision making and has developed various incentive schemes to achieve

channel coordination, there has not been much analytical work addressing the impact of power

structure.

To answer these aforementioned problems, we consider a supply chain with price-dependent

stochastic demand, consisting of a manufacturer and a retailer. Power in this paper is defined as

a firm’s ability to influence other firms’ decision making by moving first in a game-theoretical

framework, but not by dictating the decision variables of another member in the supply chain.

Within this framework, the manufacturer chooses the wholesale price, and the retailer determines

the retail margin. The game sequence is regarded as a surrogate for the relative power of the

participants. In particular, we use a manufacturer (retailer) Stackelberg game to model supply

chains with a power manufacturer (retailer). In the manufacturer-dominant supply chain, Sudhir

(2001) and Che et al. (2007) found support for the manufacturer-Stackelberg game better describing

the manufacturer–retailer relationships using nonnested model tests, while in the retailer-dominant

supply chain, the guaranteed profit margin required by the power retailers has often been cited as

a real-world example of a retailer-Stackelberg game (see, e.g., Krishnan and Soni, 1997; Liu et al.,

2009). To model supply chains with a balanced power structure, we use a vertical Nash game in

which both parties movesimultaneously (see, e.g., Lau et al., 2006). The marketdemand is stochastic

and price-dependent. For the price-dependent stochastic demand models, following the same logic

as in Petruzzi and Dada (1999), we model the effect of price on expected demand with twodifferent

methods, linear demand and isoelastic demand, and model the effect of demand shock on stochastic

demand in two different ways: multiplicativeand additive. Weprovide a detailed analysis of the base

case with linear demand and multiplicative shock. For the other three demand models, we present

only numerical insights for the sake of space, although we can obtain some key analytical solutions

for them.

In this model framework,our analysis yields the following main results. First, whethera dominant

firm benefits from its power depends on both expected demand and demand shock. In particular,

for a linear demand, the firm with more power always prefers moving first to movingsecond (we will

refer to this preference as the type-I first moveradvantage; see the detailed explanation in Section 4),

regardless of demand shock. Forisoelastic demand, this is not entirely true. Forexample, the power

manufacturer might earn a lower profit in a supply chain with additive shock.

Next, a balanced power structure is often beneficial to the whole supply chain. That is, a larger

“pie” can be created when neither firm dominates the supply chain. There exists one exception:

for a supply chain with multiplicative demand and additive shock, a balanced power structure

performs better than a power manufacturer structure, but not necessarily better than a power-

retailer structure.

Third, similar to the impact on supply chain efficiency, consumers often profit from a balanced

power structure. Specifically, for linear demand, consumers can earn the highest expected surplus

when neither firm dominates the supply chain. For isoelasticity demand, all consumer surpluses are

equal with multiplicative shock.

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2017 The Authors.

International Transactionsin Operational Research C

2017 International Federation ofOperational Research Societies