Wholesale price contract versus consignment contract in a supply chain considering dynamic advertising

• Date: 01 September 2019
• Published date: 01 September 2019
• Author: Wansheng Tang,Fuxiao Lu,Jianxiong Zhang
• DOI: http://doi.org/10.1111/itor.12388

Intl. Trans. in Op. Res. 26 (2019) 1977–2003

DOI: 10.1111/itor.12388

INTERNATIONAL

TRANSACTIONS

IN OPERATIONAL

RESEARCH

Wholesale price contract versus consignment contract

in a supply chain considering dynamic advertising

Fuxiao Lu, Jianxiong Zhang and Wansheng Tang

College of Management and Economics, Tianjin University, Tianjin 300072, China

E-mail: fxlu1990@tju.edu.cn [Lu]; jxzhang@tju.edu.cn [Zhang]; tang@tju.edu.cn [Tang]

Received 20 May2016; received in revised form 29 September 2016; accepted 6 December 2016

Abstract

Supply chain contracts are widely considered as useful and necessary tools to guide and restrict channel

members’ behaviors. Considering the effect of dynamic advertising, we investigate two distinct types of

contracts between a dominant retailer and her manufacturer. One contract is a traditional wholesale price

contract and the other is a consignment contract. The results show that, compared to the wholesale price

contract, the consignment contract is always more desirable from the perspectives of the retailer and the

entire channel and brings more consumer surplus. When the dominant retailer’s advertising effort is very

effective or channel members have enough patience,the dominant retailer and the manufacturer can achieve a

Pareto improvementunder the consignment contract; otherwise the manufacturer prefers the wholesale price

contract.

Keywords: supply chain management; differential game; dynamic advertising; consignment contract; wholesale price

contract; Pareto improvement

1. Introduction

Supply chain contracts are widely considered as useful and necessary tools to guide and restrict

supply chain parties’ behaviors. For this reason, retailers often try differentcontractual relationships

with their manufacturers.In a traditional supply chain, the products are often sold under wholesale

price contract, where the retailer purchases the product at a wholesale price from the manufacturer

and then sells it to end consumers at a retail price. The wholesale price contract is commonly

observed in practice due to its ease of implementation and administration (El Ouardighi and Kim,

2010). Alternatively, in recent years, with some retailers gradually dominating the supply chain, it

appears another type of contract, that is,the consignment contract, which has been applied in many

retailing industries, is especially popular in online marketplaces. Consignment contract actually

refers to a special contract form in which the retailer promotes a product whose ownership is

retained by the manufacturer to consumers, and no purchase of the product from the manufacturer

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International Transactionsin Operational Research C

2017 International Federation ofOperational Research Societies

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1978 F. Lu et al. / Intl. Trans.in Op. Res. 26 (2019) 1977–2003

takes place. Moreover, for each unit of the product sold, the retailer deducts a percentage from the

sales revenue (i.e., the retail price) for herself, and remits the remaining share to the manufacturer

at the wholesale price (Hackett, 1993). For example, when manufacturers’ products are sold at

Amazon.com by consignment, Amazon as a retailer will charge a percentage of the retail price as

the commission according to the item’s category, for example, 15% for shoes, 6% for computers,

20% for jewelry, and 8% for electronics and camera and photo items (for more information, please

go to http://www.amazon.com).

Based on the above description of the two contract types, it is obvious thatthere is a fixed relation

between the wholesale and retail prices under consignment contract, that is, the wholesale price is

proportional to the retail price. In contrast, under the traditional wholesale price contract, there

does not exist any compulsory constraint relation between the wholesale and retail prices. In this

case, the consignment contract at first thought does not seem to be effective, and hence has received

relatively little attention from researchers. However, we initially explore it primarily since it has

been observed in practice and is becoming prevalent in industries such as book retailing, mobile

applications, and Internet commerce (Wang et al., 2004; Avinadav et al., 2015a). In this study, the

conclusions of how the wholesale price contract and the consignment contract will perform with

the rational manufacturer and retailer, are quite interesting.

It is noted that in the past two decades, some retailing giants such as Wal-Mart, Best Buy,

Home Depot, Amazon, and Tesco have emerged. They have gradually become powerful retailers

not only because of their ability to offer consumers the unprecedented opportunity for one-stop

shopping and to manufacturers effective promotional services, but also because they are frequently

the largest distributors for manufacturers (Raju and Zhang, 2005). Sales through Wal-Mart, for

instance, account for17% of P&G’s total sales in 2002, 39% of Tandy’s, and a double-digit percentage

for many other large manufacturers (Useem, 2003). As a result, these retailers can be tough and

dominating when dealing with their manufacturers. Business Week reported that “one multinational

supplier . .. says Wal-Mart buyers in Mexico were aggressive and abusive pulling his product off

shelves for several months when he objected to a deep price cut that would have wiped out his

profits” (Smith, 2002). USA Today cites that “Big food companies including Kraft, which gets

10% of its revenue from Wal-Mart, have not been able to raise prices as quickly as they once did

because of Wal-Mart’s demands” (Xue et al., 2014). In this background, we are eager to know how

dominant retailers interact with their manufacturers under traditional wholesale price contractand

consignment contract, and their preferences for these two different types.

Additionally, most retailers face the threat of increased competition from globalization, shorter

product life cycles, and fragmenting mass markets. Survival in this new economic environment

depends on the ability to smoothly deliver the required products to consumers through their mar-

keting decisions. In this case, retailers have to execute advertisements to lure customers and boost

sales. For example, online retailers JD.com and Tmall.com advertise on radio, TV, Web, and direct

mail to alert consumers about new products, promotions, and anniversary sales, or just frequently

display their names to establish a good enterprise image and win the trust and praise of customers.

Other retailers are using different forms of social media to advertise themselves and promote their

business goodwill. For example, American Eagle has Facebook applications, while retailers such

as Wal-Mart and Target have Facebook-sponsored groups; Urban Outfitters has MySpace pages;

Buy.com, Radioshack, and Overstock.com have Youtube/Video podcasts (Ailawadi et al., 2009).

Meanwhile, it should be noted that, for any supply chain, the advertising strategy is not static but

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2017 The Authors.

International Transactionsin Operational Research C

2017 International Federation ofOperational Research Societies