Tony Haitao Cui

Contract Preferences and Performance for the Loss-Averse Supplier: Buyback vs. Revenue Sharing

Prior theory claims that buyback and revenue-sharing contracts achieve equivalent channel-coordinating solutions when applied in a dyadic supplier–retailer setting. This suggests that a supplier should be indifferent between the two contracts. However, the sequence and magnitude of costs and revenues (i.e., losses and gains) vary significantly between the contracts, suggesting the supplier’s preference of contract type, and associated contract parameter values, may vary with the level of loss aversion. We investigate this phenomenon through two studies. The first is a preliminary study investigating whether human suppliers are indeed indifferent between these two contracts. Using a controlled laboratory experiment, with human subjects taking on the role of the supplier having to choose between contracts, we find that contract preferences change with the ratio of overage and underage costs for the channel (i.e., the newsvendor critical ratio). In particular, a buyback contract is preferred for products wit...

The Length of Product Line in Distribution Channels

This paper studies a manufacturers optimal decisions on extending its product line when the manufacturer sells through either a centralized channel or a decentralized channel. We show that a manufacturer may provide a longer product line for consumers in a decentralized channel than in a centralized channel if the market is fully covered. In addition, a manufacturers decisions on the length of its product line may not always be optimal from a social welfare perspective in either a centralized or a decentralized channel. Under certain conditions, a decentralized channel can provide the product line length that is socially optimal, whereas a centralized channel cannot.

A Price Discrimination Model of Trade Promotions

Critics have long faulted the wide-spread practice of trade promotions as wasteful. It has been estimated that this practice adds up to

Fairness Ideals in Distribution Channels

100 billion worth of inventory to the distribution system. Yet, the practice continues. In this paper, we propose a price discrimination model of trade promotions. We show that in a distribution channel characterized by a dominant retailer, a manufacturer has incentives to price discriminate between the dominant retailer and smaller independents. While offering all retailers the same pricing policy, price discrimination can be implemented through trade promotions because they induce different inventory-ordering behaviors on the part of retailers. Differences in inventory holding costs have been shown to be an important determinant of consumer promotions. Our analysis suggests that differences in holding costs are also potentially an important driver for the use of trade promotions. The implications from our model explain a number of anecdotal and/or empirically observed puzzles about how trade promotions are practiced. For example, our analysis explains why chain stores welcome trade promotions but independents do not. Our analysis outlines implications for managing trade promotions.

When Acquisition Spoils Retention: Direct Selling vs. Delegation Under CRM

The authors analytically and experimentally evaluate how firms make decisions in a two-stage dyadic channel, in which firms decide on investments in the first stage and then on prices in the second stage. They find that firms’ behavior differs significantly from the predictions of the standard economic model and is consistent with the existence of fairness concerns. Using a quantal response equilibrium model, in which both manufacturer and retailer make noisy best responses, the authors show that fairness significantly affects channel pricing decisions. In addition, they investigate what affects the perceptions of fairness. More specifically, they analyze whether the notion of fairness is influenced by social norms of strict equality, by endogenous investments and contributions that are affected by players’ decisions, or by the exogenous game structure. To do so, the authors compare four principles of distributive fairness: strict egalitarianism; liberal egalitarianism; libertarianism; and a sequence-aligned ideal, which is studied for the first time in the literature. Surprisingly, the exogenous game structure reflected by the new ideal, whereby the sequence of moving determines the equitable payoff for players, significantly outperforms other fairness ideals, suggesting that equity in distribution channels can arise even in contests in which channel members have fairly different payoffs.

Cognitive Hierarchy in Capacity Allocation Games

The widespread implementation of customer relationship management technologies in business has allowed companies to increasingly focus on both acquiring and retaining customers. The challenge of designing incentive mechanisms that simultaneously focus on customer acquisition and customer retention comes from the fact that customer acquisition and customer retention are usually separate but intertwined tasks that make providing proper incentives more difficult. The present study develops incentive mechanisms that simultaneously address acquisition and retention of customers with an emphasis on the interactions between them. The main focus of this study is to examine the impact of the negative effect of acquisition on retention, i.e., the spoiling effect, on firm performance under direct selling and delegation of customer acquisition. Our main finding is that the negative effect of acquisition on retention has a significant impact on acquisition and retention efforts and firm profit. In particular, when the customer acquisition and retention are independent, the firms profit is higher under direct selling than under delegation; however, when acquisition spoils retention, interestingly, the firms profit may be higher under delegation. Our analysis also finds that the spoiling effect not only reduces the optimal acquisition effort but may also reduce retention effort under both direct selling and delegation. Comparing the optimal efforts under direct selling and delegation, the acquisition effort is always lower under delegation regardless of the spoiling effect, but the retention effort may be higher under delegation with the spoiling effect. Furthermore, when the customer antagonism effect from price promotions is considered, our main results hold regarding the firms preferences between direct selling and delegation, which demonstrates the robustness of our model. This paper was accepted by Pradeep Chintagunta, marketing.

S-Shaped Incentive Schemes and Pay Caps

We examine a supply chain with a single supplier and multiple retailers to predict retailers’ actual ordering behaviors. If retailer orders exceed supplier capacity, a proportional rationing rule applies to capacity allocation among retailers. We propose a behavior model based on cognitive hierarchy theory, in which retailers with different levels of strategic-reasoning capabilities form heterogeneous beliefs about other players’ capabilities when choosing their orders. This behavioral model yields three interesting predictions. First, retailers’ orders increase as the number of retailers decreases or the supplier’s production capacity shrinks. Second, the orders tend to increase as the retailer population becomes more “sophisticated”. Third, retailers’ profits first increase in relation to their strategic-reasoning capabilities and then decrease, indicating an inverted U-shaped relationship between profits and strategic-reasoning capabilities. We experimentally examine the capacity allocation game with participants motivated by financial incentives. The experimental results and structural model estimation confirm the predictions of the behavioral model.

How to Organize Tiered Competition for Prescription Drugs?: Formulary Structure and Bargaining Process

S-shaped incentive schemes and pay caps are fairly common in practice. This paper demonstrates the optimality of s-shaped incentive schemes and pay caps by incorporating salespeople’s aversion to pay inequity into the standard agency model. Our analysis shows that salespeople’s desire for pay fairness increases the convexity of the optimal incentive scheme at small sales but increases the concavity at large sales. Consequently, the optimal compensation plan is s-shaped. With aversion to pay inequity, the optimal incentive scheme always contains an upper bound for total payment. For practical implementation, we propose a capped quota plan to approximate the optimal s-shaped scheme. Our numerical analysis indicates that the capped quota plan has an average non-optimality of less than 2% in parametric spaces studied. The numerical analysis also explores the sources of non-optimality and the relationship between market characteristics and the optimal size of pay caps.

Service Failure Recovery and Prevention: Managing Stockouts in Distribution Channels

Most prescription purchases in the US are covered by health insurance. Insurance companies typically develop a formulary structure to reduce the drug costs and improve patients’ access to drugs. In this paper, we study how the formulary structure affects price competition between competing drugs, which in turn affects market shares and the total market size. We characterize an insurance plan’s optimal strategy in terms of the number of drugs in the formulary, patients’ copay amount, and the structure of the bargaining process. We develop a game-theoretic model of strategic interactions among an insurance plan and two manufacturers of competing patent-protected drugs. The insurance plan in our model can negotiate prices with each drug company in return for providing insurance coverage to their products. We show that the insurance plan’s ability to accomplish cost- and access-related objectives varies significantly across different formulary structures and bargaining processes. Specifically, the insurance plan can better meet its objectives by putting both drugs in the formulary when the cross-price effects are not very large. On the other hand, when the cross-price effects are sufficiently strong, the insurance plan’s optimal strategy is to include only one drug in the formulary. Our analysis further suggests that sequential bargaining is better for the insurance plan than simulatenous bargaining. Although some of the gains to the insurance plan come at the expense of drug companies, there are cases in which the creation of a formulary may also benefit one or both drug companies, resulting in a win-win situation.

Reference Dependence in Multilocation Newsvendor Models: A Structural Analysis

In managing service failures such as stockouts, most research has emphasized preventive mechanisms, whereas stockout recovery mechanisms have been largely ignored. We propose and examine a failure-recovery mechanism i.e., contractual stockout recovery in the presence of demand uncertainty and compare it with failure-prevention mechanisms in a dyadic distribution channel. We find that stockout recovery mechanisms can improve channel profitability under certain conditions. More importantly, we find that stockout recovery may outperform stockout prevention mechanisms such as return policy and vendor managed inventory in improving manufacturer and channel profitability. This is because stockout recovery reduces channel-wide stockout risks and allows benefits from the reduced risks to be shared between the manufacturer and the retailer, helping alleviate double marginalization. Although return policy also reduces stockout risks, it does so by increasing inventory risks in the channel without reducing channel exposure to demand uncertainty. Thus, our research suggests that stockout recovery can be an effective alternative in managing stockouts to those common methods of stockout prevention mechanisms.