Vertical integration with price-setting competitive newsvendors

Chongqi Wu, Nicholas C. Petruzzi, Dilip Chhajed

Research output: Contribution to journalArticle

Abstract

This article addresses the problem of distribution channel design under demand uncertainty. We consider two manufacturers, each producing a substitutable product and selling it through either a decentralized or an integrated retail store, which is modeled as a price-setting newsvendor. A multiplicative demand function incorporating a random shock term is assumed. Of primary interest is how demand uncertainty and production cost affect the equilibrium distribution channel structure. Results indicate the following: On the one hand, if the random shock term is uniformly distributed on [0, x], then the equilibrium design does not depend on the variance of the shock. On the other hand, if the random shock term is uniformly distributed on [1 - r, 1 + r], then the equilibrium design does depend on the variance of the shock. In particular, an increase in r favors the integrated structure where both channels are integrated and hurts the decentralized configuration where both channels are decentralized. Additionally, we explain the qualitative similarities and differences between the structural properties of the equilibrium distribution channel structure when demand is, and is not, uncertain. We also establish that production cost always favors the decentralized structure, while it hurts the integrated one. One important managerial implication of our study is that, by reducing the number of decisions made in supply chains, the impact of demand uncertainty can be controlled to a certain extent.

Original languageEnglish (US)
Pages (from-to)581-610
Number of pages30
JournalDecision Sciences
Volume38
Issue number4
DOIs
StatePublished - Nov 1 2007

Keywords

  • And Vertical Integration
  • Competitive Newsvendors
  • Distribution Channels
  • Game Theory

ASJC Scopus subject areas

  • Business, Management and Accounting(all)
  • Strategy and Management
  • Information Systems and Management
  • Management of Technology and Innovation

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