Supply Chain Structures On The Internet: Marketing-Operations Coordination

Abstract

The widespread adoption of the Internet has resulted in the possibility of disintermediation of information flow and physical goods flow: a company selling a product no longer has to own/deliver it to the customer. As a result, supply chain structures arise in which the retailer is primarily concerned with customer acquisition, and the wholesaler takes care of inventory and fulfillment. This form of doing business on the Internet is identical to the practice of drop-shipping that some catalog companies employ. A recent survey indicates that more than 30% of online-only retailers use drop-shipping as a primary way to fulfill orders. Since marketing and operations functions under such arrangement are performed by separate companies, new ineffeciencies arise that result in suboptimal system performance. In this paper, we analyze the interaction between a wholesaler and a single retailer for drop-shipping supply chains. Three distinct drop-shipping models are considered: with a powerful wholesaler, with a powerful retailer and with a wholesaler and a retailer having an equal power. Further, we conduct a comparative analysis between the drop-shipping supply chains, a vertically integrated supply chain, and the traditional structure in which the retailer both holds inventories and acquires customers. Optimal solutions are obtained for both the traditional and drop-shipping models, and we show that both solutions are system sub-optimal. We demonstrate how decision power in the chain affects decision variables and profits. It is found that both channel members prefer drop-shipping agreements over the traditional agreements for a wide range of problem parameters. One of our main results is that none of the mechanisms described in the literature on channel coordination (except for those that allow side payments) are able to induce a optimal system behavior in the presence of customer acquisition expenses. We therefore propose a new coordination scheme where, in addition to using a returns contract (for the traditional supply chain structure) or a penalty scheme (for the drop-shipping structure), the wholesaler subsidizes a part of the retailer's marketing expenses. Extensive comments are provided on the comparative benefits of traditional and drop-shipping supply chains.