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Why do suppliers choose wholesale price contracts? End-of-season payments disincentivize retailer marketing effort

Abstract

Although theoretical work has shown that end-of-season payment contracts, which allow suppliers and retailers to share the cost of unsold inventory, increase total profit, most suppliers and retailers today still use simple wholesale price contracts. In a series of experimental studies, we show that supplier preferences for wholesale price contracts can be explained by their concern that end-of-season payments contracts will disincentivize retailer marketing effort. Moreover, suppliers’ pessimistic predictions regarding reduced retailer effort are confirmed by retailers’ reduced investment in marketing effort in our experiments. Our results suggest that for suppliers and retailers to benefit from end-of-season payments contracts, retailers should publicize their demand-enhancing marketing practices.

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Acknowledgements

The authors would like to acknowledge funding for this research from the National Science Foundation (an ADVANCE Grant to the coauthors for “Understanding the Appeal of Suboptimal Contracts”). They would also like to thank the Editor, Associate Editor and three reviewers for very helpful suggestions on previous versions of this manuscript, and their colleagues at the INFORMS, POMS, Behavioral Operations Management and Theory + Practice in Marketing conferences for their very helpful suggestions on this research.

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Correspondence to Rebecca W. Hamilton.

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Dhruv Grewal served as Area Editor for this article.

Appendix

Appendix

Study 1 stimuli

Attention/Comprehension Checks for Contracts

Questions Multiple Choice Options (correct answer in bold)
Under which form of contract is the retailer solely responsible for leftover items? • Wholesale price contract
Buyback contract
If you offer the retailer a buyback contract, under what circumstances do you pay the retailer a buyback payment? When demand is higher than the retailer’s order quantity
When demand is equal to the retailer’s order quantity
• When demand is lower than the retailer’s order quantity
All else being equal, the value of a leftover item (not sold during selling season) to the retailer is: The same under WP and BB contracts
Greater under WP than BB contract
• Less under WP than BB contract

Decision Setting Information

  High Cost Condition Low Cost Condition
Demand Distribution Uniform: [110, 510] *
Effort level options 0, 1, or 2 *
Increase per unit effort 60 units *
Cost for 1 unit effort 200 *
Cost for 2 units effort 645 (total) 450 (total)
Contract parameters WP: 43
BB: 40, 30
*
Profit-maximizing order quantity WP: 310
BB: 530
*
Profit-maximizing effort level WP: 2
BB: 2
*
Expected profit WP: 6820
BB: 7646
*
  1. *Indicates information was the same across cost conditions

Manipulation Checks

Question Answer type
Rate the retailer’s cost of exerting 1 unit of effort Scale of 1 (cheap) to 7 (expensive)
Rate the retailer’s cost of exerting 2 units of effort Scale of 1 (cheap) to 7 (expensive)
If the retailer decides to exert 1 unit of effort, demand for the product will be: • Remain between 110 and 510 units
• Increase to between 170 and 570 units
• Increase to between 230 and 630 units
If the retailer’s cost of exerting 2 units of effort increases, I would expect the retailer to be: • More likely to exert 2 units of effort
• Less likely to exert 2 units of effort
• Equally likely to exert 2 units of effort

Dependent Measures

Question Answer Options
Which contract would you like to offer the retailer? • Wholesale price contract
• Buyback contract
Please use the sliding scale to indicate which contract you believe effort will be higher under • WP contract (slide scale to left = 1)
• BB contract (slide scale to right = 7)
What level of effort do you think Highland Fashions will exert under the WP contract? • 0 units (cost of 0, no increase in demand, no increase in profit)
• 1 units (cost of 200, 60 unit increase in demand)
• 2 units (cost of 450 (or 645), 120 unit increase in demand)
What level of effort do you think Highland Fashions will exert under the BB contract? • 0 units (cost of 0, no increase in demand, no increase in profit)
• 1 units (cost of 200, 60 unit increase in demand)
• 2 units (cost of 450 (or 645), 120 unit increase in demand)

Scale Questions

For each of the following statements, please use the sliding scale to indicate the degree to which you think the statement is:

  • “More True of WP” (by sliding to the left = 1)

  • “More True of BB” (by sliding to the right = 7)

  • “Same for Both” (by leaving the sliding scale in the center = 4).

Scale Items Source
Retailer opportunism • Under this contract, I believe the retailer would lie about certain things to protect their interests.
• Under this contract, I believe the retailer will promise to things without actually doing them later.
• The retailer will try to take advantage of wiggle room in this contract to further their own interests.
Rokkan et al. 2003 , Liu et al. 2010 ; alpha of 0.75–0.91
Contract complexity • I found this contract complicated.
• I found this contract difficult to use.
• This contract requires a lot of time to use properly.
Adapted from Marketing Scales Handbook: Volume 7 Bruner
Perceived control • When using this contract, I feel in control.
• This contract lets me (the supplier) be in charge.
• This contract gives me control over profits.
Adapted from Collier and Sherrell 2010 ; alpha of 0.90
Power • This contract benefits me (the supplier) more than the retailer.
• This contract gives me leverage over the retailer.
• This contract allows me to influence the decisions made by the retailer.
• This contract allows me to convince the retailer to take specific action.
Adapted from Gregoire et al. 2010 ; alpha of 0.94 and 0.90
Perceived risk of contract performance • My (the supplier’s) profits are risky under this contract.
• If I were offering this contract, I would be concerned about my potential profits.
• Offering this contract to the retailer would leave me worried about my potential profits.
Adapted from Marketing Scales Handbook: Volume 7 Bruner
Perceived risk of depending on retailer effort • This contract leaves me vulnerable to the retailer’s actions.
• I am concerned about my dependency on the retailer’s actions when I use this contract.
• Offering the contract to the retailer would leave me worried about my dependency on the retailer’s actions.
Adapted from Marketing Scales Handbook: Volume 7 Bruner
Perception of contract profit • If I offer this contract to the retailer I can earn high profits.
• The ability to earn high profits is a reason to offer this contract.
 
Supplier belief about retailer focus on cost rather than revenue • Under this contract, I believe the retailer will focus more on their costs than their revenues.
• Under this contract, I believe the retailer will focus more on the cost of exerting effort now than an increase in revenue later.
 

Study 2 stimuli

Decision Setting Information

Same as in Study 1.

Dependent Measures

Question Potential Answers
What level of effort would you like to exert?* • 0 units (resulting in 0 cost and demand between 110 and 510 units)
• 1 unit (resulting in 200 cost and demand between 170 and 570 units)
• 2 units (resulting in 450 (or 645) cost and demand between 230 and 630 units)
  1. *This question was asked twice, once for the WP contract and once for the BB contract.

Study 3 and Study 4 stimuli

Marketing Effort Manipulation

Condition Description of Retailer
Low marketing effort condition You have gathered some information about the retailer’s business practices and reputation. For example, you know that Highland Fashions does not actively promote items in their store via ads or targeted emails to customers throughout the season. They also do not go to great lengths to maximize foot traffic throughout their store. Recently, customers have noticed that the retailer is either understaffed or the salespeople have not been very helpful.
Control Condition You have not been able to gather information about the business practices of both retailers.
High marketing effort condition You have gathered some information about the retailer’s business practices and reputation. For example, you know that Highland Fashions actively promotes items in their store via ads or targeted emails to customers throughout the season. They also go to great lengths to maximize foot traffic throughout their store. Recently, customers have commented that the salespeople are very helpful.

Decision Setting Information

  Season A Season B
Demand distribution Uniform [150,350] Uniform [200,500]
Retail price 48 32
Production cost 12 8
Retailer salvage value 24 16

Dependent Measures (before presentation of contracts)

  Season A Season B
How many units do you expect (the retailer) to sell during the selling season? Slide cursor between 150 and 350 units Slide cursor between 200 and 500 units
Please indicate how successful you think (the retailer) will be in selling (items) this season? Sliding scale from 1 (not successful) to 7 (very successful) Sliding scale from 1 (not successful) to 7 (very successful)

Contract Parameters

  Season A Season B
Wholesale price 45 30
BB/MM price 12 24
Expected profit WP: 5511
MM: 6524
WP: 5214
BB: 5823

Dependent Measures (after presentation of the contracts)

Which contract would you prefer to offer the retailer? – Wholesale price contract
– Markdown money contract
– Wholesale price contract
– Buyback contract

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Devlin, A.G., Elmaghraby, W. & Hamilton, R.W. Why do suppliers choose wholesale price contracts? End-of-season payments disincentivize retailer marketing effort. J. of the Acad. Mark. Sci. 46, 212–233 (2018). https://doi.org/10.1007/s11747-017-0550-9

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Keywords

  • Contracts
  • Incentives
  • Retailer
  • Supplier
  • Supply chain relationships