The Bargaining Power in Supply Chain and Optimal Hybrid Marketing Channel Strategies Academic research paper on "Economics and business"

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Social and Behavioral Sciences

Procedía - Social and Behavioral Sciences 109 (2014) 1343 - 1347

2nd World Conference On Business, Economics And Management- WCBEM2013

The Bargaining Power in Supply Chain and Optimal Hybrid Marketing Channel

Strategies

Se-Hak Chuna*

a Department of Business Administration, Seoul National University of Science and Technology, Kongneung-gil 138, Nowongu, Seoul 139-743, Republic of Korea email:shchun@seoultech.ac.kr, Tel:82-2-970-6478, Fax:82-2-970-6487

Abstract

This paper analyzes how the bargaining power in supply chain affects marketing channel strategies of a manufacturer when it considers a direct online channel using a simulation method, and discusses some strategic implications from the perspective of market transaction costs and the portion of online customers. This paper shows interesting results: when relative online purchasing cost is very low, a manufacturer chooses a matching strategy, when online purchasing cost is moderate, it chooses a hybrid channel strategy rather than a price matching strategy, and it chooses offline strategy only when online purchasing cost becomes high.

© 2014 The Authors. Published by Elsevier Ltd.

Selection andpeer review under responsibility of OrganizingCommitteeof BEM 2013. Keywords: Bargaining Power, Channel Management, Direct Online Channel, Electric Commerce;

1. Introduction

The Internet has led many manufacturers (or conventional retailers) to add a direct online channel to their existing retail networks. Some manufacturers such as IBM, Hewlett-Packard, Pioneer Electronics, Sony, Kodak, Minolta, Panasonic, Cisco, the former Compaq, Mattel, Estee Lauder and Nike, to add direct online channels to their existing retail networks (Kumar and Ruan, 2006; Tsay and Agrawal, 2004, Chun et al., 2011; Chun, 2012). However, some manufacturers such as JVC, NEC, 3M, Nikon, Cannon, Olympus, Samsung and LG have used the Internet as a mere medium to provide information about their products without selling via their websites. These examples show that many manufacturers have different channel strategies.

This paper extends Chun (2012)'s model and focuses on analyzing a manufacturer's channel strategies using simulation methods, and discusses some strategic implications from the perspective of market transaction costs and the portion of online customers. In particular, how the bargaining power between a manufacturer and retailer affects on manufacturer's channel management strategies. This paper compares two multichannel models which are a Stackelberg leader model and pricing matching model. Although Cattani et al. (2006) analyzed a pricing matching model, they did not consider a channel conflict situation. This paper analyzes a multichannel model in terms of bargaining power between a manufacturer and a traditional retailer.

* Corresponding Author: Se-Hak Chun. Tel.: +82-2-970-6487 E-mail address: shchun@seoultech.ac.kr

1877-0428 © 2014 The Authors. Published by Elsevier Ltd.

Selection and peer review under responsibility of Organizing Committee of BEM 2013. doi: 10.1016/j.sbspro.2013.12.635

The remainder of this paper is organized as follows: Section 2 presents and analyzes the hybrid and matching model. Section 3 discusses results of the study with strategic implications. In section 4, conclusions and future research are discussed.

2. The Model

I extend Chun (2012)'s model and analyze a model when a manufacturer launches a direct online channel in competition with the traditional offline retailer. I assume the commonly used spatial competition model of Hotelling (Tirole, 1995) and use Chun and Kim's model (Chun and Kim, 2005; Chun 2012). I assume that a linear city of length s and the unit production cost of both a retailer and a direct online channel of the manufacturer is equal to c. Consumers are distributed on [0, s]. I assume that the location of a retailer is at 0. Thus a consumer located at 0 has maximum valuation of the good, V, and others preferences are decreasingly differentiated according to s. Each consumer consumes one or zero units of the good. A fraction of consumers at each location point, m, have a strong preference on offline services and they are served from distributors or retailers' product services. They are a group of "service sensitive group" (Chun et al., 2011). The other group, 1-m, can have access to the Internet and they are "price sensitive group" who are easily switch from offline to online when they compare two channel's transaction costs and prices. Thus, this group of consumer may buy the good from the offline retailer, in which case the consumer has to travel to the retail store and pay transportation cost ts, where t is the transportation cost per unit of length. If the consumer buys the good from the online firm, the consumer incurs cost, a, which may be search cost and other costs related to quality uncertainty, security risk, and delivery cost. Then, the utility of a consumer with the Internet access (or a group of "price sensitive", easily switchable consumer group from offline to online) located at s is:

V - pr - ts if he buys from the offline firm .V - pd - a ifhebuys fromthe online firm 0 if he does not buy,

where p and pd are the prices charged by the offline and online firms.

2.1. Hybrid Channel Model (More Bargaining Power on Manufacturer)

In the hybrid model, I assume a manufacturer Stackelberg leader model that a manufacturer uses an online channel as a market leader. Thus, the manufacturer takes the retailer's reaction function in consideration in order to find wholesale price, w, and a direct online price, pd, maximizing its profit. The retailer profit function is

n- = m(pr - w)(V-P-1 + (1 - m)(pr - w)( p + a - P

t ) \ t In the first period, using the retailer's reaction function, the manufacturer finds wholesale price and its direct online price from its profit function as follows;

n M = m(w - c)Ç V-pr. j + (1 - m)(w - c)|Pd + a - p j + (1 - m)( pd - c)|i - Pd + a - p j.

From these profit functions, optimal prices are derived as follows;

H t V + c -1

wH =-+-,

H t V + c - a

pH — +-,

D 2m 2

H t V + c -1 a V - c - a

pR =-+-+ — +-m

2m 2 4 4

2.2. The Price Matching Model (Less Bargaining Power on Manufacturer)

In this model, I assume that a manufacturer has less bargaining power than the hybrid model. Many manufacturers use price matching strategies because of channel conflict. I assume that a manufacturer sets its online price the same as the existing offline retailer's price, thus Prm =Pdm, where m denotes the matching model. Then, the profit of the manufacturer can be given by

nM = (pr - w)Qr = (pr - + (1 - m)

Like the hybrid model I assume that the manufacturer is a leader and it anticipates the retailer's price and decides its whole sale price. Using backward induction, in the 2nd period, the retailer finds an optimal retail price to maximize its profit. Thus, the retailer finds the optimal retail price as given by

pM = -1 (Vm - cm + mm + a). 2m

Then, the manufacturer finds optimal wholesale price to maximize its profit. Then, wholesale price and retail price is derived as follows;

mf = -1 (t + Vm + cm - tm), = -1 (2a +1 + 3Vm - 2am + cm - tm). 2m 4m

3. The Results of the Study

Table 1 shows the equilibrium prices for the basic model, hybrid model and matching pricing strategy.

Models Equilibrium Prices

Leader Model H t V + c -1 H t V + c - a H t V + c -1 a V - c - a a> =-+-pD =-+- pR =-+-+ — +-m 2m 2 2m 2 2m 2 4 4

Matching Model M t V + c -1 M .. i i mM = — +---, pD = pt = - (2a +1) + — (3V - 2a + c -1) 2m 2 4m 4

Using these prices I obtain the profits and then, compare two models. The matching model can be regarded when a manufacturer has less bargaining power, thus, the manufacturer sets price passively. So I discuss how the bargaining power can affect the equilibrium prices and its profits, and channel strategies. I use same parameters for comparison two models as Chun (2012) using a maple's mathematical software for simulation. Table 2 and 3 show the results of profits of leader model and matching model respectively. Each scenario is when V=30, c=10, t=2.5 for an example of manufacturer's profits.

Table 2. Profits of the Leader Model when V=30, c=10, t=2.5

The none-area means outside cases when optimal solutions cannot be derived because assumptions are violated. The white-area denotes conditions when a manufacturer can add its new direct online channel. As shown in table 2, the manufacturer gets more profits as m (sensitive customer group) and a (inconvenient cost) increase.

Table 3. Profits of the Matching Model when V=30, c=10, ¿=2.5

0.3 0.4

0.5 0.6

The none-area means outside cases when optimal solutions cannot be derived because assumptions are violated. The white-area denotes conditions for pricing matching strategy when it adds its new direct online channel. As shown in table 3, the manufacturer gets more profits as m (sensitive customer group) increases while a (inconvenient cost) decreases. This is little differences between two models. These results imply that when a is larger, the manufacture should not add its new online channel. Both models show the profits of the manufacturer increase in m. Also as expected, the matching model has lower profit than a leader model because of weak bargaining power.

However, when relative costs between online and offline market are larger, very interesting results can be obtained. For this, I compare two models when c is relatively large (or offline market has more inconvenience than online market) with the case of V=30, c=15, /=2.5. As Chun (2012) shows that apparently when m and a are lower the manufacturer tends to launch its online business, when a is lower or c is higher, the manufacturer tends to add his online marketing channel. But, as shown in table 2 and 3, because of equilibrium condition, the manufacture can have experience to lose its profit when it adds a new online channel. For example, when m=0.4 and a=0.1, the manufacture will lose its profit when it adds an online channel, however, if it can use matching strategy, it can obtain more profit than when it does not adds an online channel and sells its product offline only. The table 4 shows these examples.

Table 4. Optimal Channel Strategies when V=30, c 15, /=2.5

a m 0.01 0.1 1 2 3

0.1 Profits of Models Offline model 11.25 11.25 11.25 11.25 11.25

Leader model none none none none none

Matching model none none none none none

0.25 Profits of Models Offline model 11.25 11.25 11.25 11.25 11.25

Leader model none 12.35 11.81 11.29 10.87

Matching model 11.94 11.83 10.37 none none

0.5 Profits of Models Offline model 11.25 11.25 11.25 11.25 11.25

Leader model none none none 11.71 11.27

Matching model 11.39 11.28 10.05 8.5 none

0.9 Profits of Models Offline model 11.25 11.25 11.25 11.25 11.25

Leader model none none none none none

Matching model 11.26 11.22 10.95 10.65 none

Table 4 shows that when a is very low (or online is very convenient) the manufacturer chooses a matching strategy and its profit increases as price sensitive (or online customer group) increases. However, online purchasing is moderately convenient, the manufacture choose a hybrid channel strategy rather than a price matching strategy. And last the manufacturer choose offline only model without adding an online channel when buying online becomes inconvenient (as a becomes higher), however, as online customer group become larger (m increases), the manufacturer may choose a hybrid strategy. But, in the case of high m and high a, the manufacturer selects offline selling strategy.

4 Conclusion

In this paper, I analyzed a manufacturer's channel strategy when it considers an online store. Through analytical and computational simulation methods this paper has drawn some important implications. This paper gives very interesting results on the manufacturer's optimal channel strategies. When relative online purchasing cost is very low and a manufacturer chooses a matching strategy. However, online purchasing cost is moderate, a manufacture choose a hybrid channel strategy rather than a price matching strategy. And, a manufacturer choose offline only model without adding an online channel when online purchasing cost becomes high, however, this offline only selling strategy can be mitigated when online customer group become larger and then a manufacturer may choose a hybrid strategy. In case of high density of service sensitive group and high cost of online purchasing a manufacturer selects offline selling strategy. Future study needs more detailed analysis using an analytical method and simulation technique.

Acknowledgments. This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2012S1A5A2A01016673)

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