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Retailer or e-tailer? Strategic pricing and economic-lot-size decisions in a competitive supply chain with drop-shipping

  • Theoretical Paper
  • Published:
Journal of the Operational Research Society

Abstract

Drop-shipping is an arrangement whereby an e-tailer, who does not hold inventories, processes orders and requests a manufacturer to ship products directly to the end customers. To explore the economic benefits of adopting drop-shipping distribution strategy in a competitive environment, we investigate the profitability and the efficiency of the drop-shipping channel as compared to the traditional channel. Specifically, we develop Economic Order Quantity (EOQ) games with pricing and lot-sizing decisions to examine the strategic interactions between a manufacturer and its retailer/e-tailer in the traditional/drop-shipping distribution channels. We identify conditions under which the drop-shipping channel profitably outperforms the traditional one. It is found that the economic interests of adopting drop-shipping distribution for the channel members may not always be consistent. There are cases where only the manufacture would favour drop-shipping. In this study, we also reveal that the inefficiency caused by lack of coordination in the traditional channel can be alleviated in the drop-shipping channel where the lot-sizing decision is made by the manufacturer.

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Acknowledgements

The authors thank the anonymous referees for their valuable comments and constructive suggestions.

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Authors and Affiliations

  1. City University of Hong Kong, Kowloon, Hong Kong

    W K Chiang

  2. University of Maryland, MD, USA

    Y Feng

Authors
  1. W K Chiang
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  2. Y Feng
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Appendices

Appendix A. The centralized traditional channel

The profit function of the centralized traditional channel is given by

The first-order condition with respect to p, Q are:

Then we have the following relationship between the retail price and the ordering quantity:

The optimal solutions of p, Q are inter-related. Then we have:

The profit function Π 1(Q) is a convex-concave function of Q. A line-search algorithm specified below can be applied to find the optimal solution for the problem:

Step 1::

Let k=0 and Q 0=∞.

Step 2::

Compute

Step 3::

Compute

Step 4::

If |Q k+1−Q k|<ε, stop. Otherwise let k=k+1 and go to Step 2.

Appendix B. The centralized drop-shipping channel

The profit function of the centralized drop-shipping channel is given by

The first-order condition with respect to p, Q are:

Similar to the previous analysis, we have the following relationship between the retail price and the production plan:

Then we get:

It can be verified that this objective function is also a convex-concave function. A similar line-search algorithm in Appendix A can be applied to find the optimal solution.

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Chiang, W., Feng, Y. Retailer or e-tailer? Strategic pricing and economic-lot-size decisions in a competitive supply chain with drop-shipping. J Oper Res Soc 61, 1645–1653 (2010). https://doi.org/10.1057/jors.2009.139

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  • DOI: https://doi.org/10.1057/jors.2009.139

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