The effect of full or partial pricing integration on supply chain management

Abstract

A previous paper proposed a supply chain model, comprised of a retailer and manufacturer, in which the manufacturer uses product pricing to maximize the profit of the entire supply chain. The increased profits gained from integration are then shared among all the supply chain members. The optimal pricing strategy was shown to be “products on consignment” for sale. The present study extends this simple two-layer supply chain model to a more complicated three-layer model, in which the supply chain comprises not only the retailer and manufacturer, but also an intermediate distributor. In contrast to the previous model, the present model not only considers the role of the distributor, but also the effects of product nonconformance at each facility in the supply chain. The profit function of each facility in the supply chain is established, including the sales revenue, procurement cost, and quality control cost. The investment cost at the retailer to improve the service level is also considered. It is shown that the total profit of the supply chain is maximized when the retailer’s optimal service level is adopted, where this service level is adjusted in accordance with the distributor’s unit sale price. Furthermore, after price integration, the overall profit of the supply chain is found to equal the retailer’s profit. In other words, the total profit of the manufacturer and distributor is equal to zero. Numerical examples are given to illustrate the proposed pricing integration model under different quality environments. The results are contrasted with those obtained using a traditional pricing model, namely the “make up on cost’’ model. Overall, the present results show that the manufacturer is always the winner under partial price integration (i.e., only the retailer and distributor join the integration). Furthermore, partial integration is far less profitable for the retailer and distributor than full integration.