Pricing and Supply Chain Management in Electronic Commerce

Pricing and Supply Chain Management in Electronic

Commerce

Professor Phillip J. LedererWilliam E. Simon Graduate School of Business Administration

University of Rochester

Rochester NY

14627

05/24/10 ©Professor Phillip J. LedererWilliam E. Simon Graduate School of Business Administration

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Trends in Supply Chains & Electronic Commerce

• ECR, CRP

• New Distribution Channels

• Outsourcing of Supply Activities

Pricing Issues Are Important In All of These


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Economic Factors Driving Supply Chain DevelopmentsComplementarities Between


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Economic Trends Driving These Developments

• Lower IS Costs – IS Costs Drive

• Search and information costs• Monitoring and control costs


5

Economic Trends Continued

• More Efficient Operations Technologies– BPR– JIT

• Innovative Contracts– Redefining Services– Longer Term Relationships– Joint Investments and Risk Sharing


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How Pricing/Contracting Interacts With Supply Chains In

Electronic Commerce

• Why Have New Contracting Forms Arisen In Supply Chains?

• What Are Pricing Opportunities With ELP?

• How Do New Distribution Channels Affect Technology Adoption and Pricing Policies?


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We Present Three Case Studies

• ECR For Custom Manufacturer– New Contract Relationship

• P&G ELP Pricing Policy – Use of Uniform Delivered Pricing

• Distribution Channels For Banking Services– Electronic Channels & Branches– Pricing These Services


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Case Study I: Central Printers

• Largest Printer of Canned Labels In US

• Has Adopted A Number of Innovative Supply Chain Strategies


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Central Printers, Continued

• Before:

• Printer --- Super Market Chain --- Packer


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Central Printers, Continued, • After:

• Printer --- Super Market Chain --- Packer


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Key Changes That Central Printer Made

• Eliminated One-Echelon

• Changed Contract Agreement– Printer Managed (and Owned) Inventory For

Client– Service Terms plus Price Negotiated– Obsolescence Costs Imposed on Client

• Improved Operational Capability


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Improvement Required New Contract Arrangement

• Key Change Was Central Printer Guaranteeing Service Level

• Central Printer Needs To Make Both The Capacity and The Inventory Decision

• An Agency Conflict Occurs If Central Printers Makes Inventory Decision For Client


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Generalization• An “Agency” Problem Exists When One

Party Makes Production Decisions and Another Makes Inventory Level Decision

• Typical Decisions Made In Chain– Supplier: Wholesale Price

Factory Inventory– Customer Retail Price

Local Inventory


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Examples of Literature

– Kandel 1990 – Lariviere and Porteus 1995 – Zipkin and Cashon 1997– Anupindi and Bassock 1998


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Key Problem: “Double Marginalization”

• To Maximize Chain Profit, Agent’s Profit Incentives Must Be Aligned;

• Decentralized Decisions Are Suboptimal


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Problems Creating Alignment

• Differences in Profit Margins

• Differences In Inventory Holding Costs and Stockout Costs

• Differences In Information About The Demand Distribution


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Typically

• Decentralized Inventory Decisions– Reduce Chain Profit Due to

• High Prices• Low Service Levels• Low Inventory

• Independent of the Agency Problem– Inventory Stocking Locations Not Optimized


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Solutions• Service Levels Are Set With Penalties For

Stockouts

• Return Policy For Output

• Producer Makes Production and Inventory Decisions– Vendor Managed Inventory– Consignment System


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Case Study II: P&G’s ELP Pricing Policy

• Identical Delivered Prices To All Customers– Formerly, Customers Paid Freight

• Fixed Prices With Allowances For Yearly Volume– Eliminated Forward Buying– Reduced Variability in Factory Loading– Reduced Billing Errors


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Case Study, Continued

• We Study The Effect of ELP On Pricing Strategy and Profits


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Example: Sunny Delight

*

*

* *

x

Analysis: Let A Firm Have Three Plants

• It Sets A Mill Price From One of ThemProfile of Prices and Costs

mill site

factory 2 factory 1 factory 3

delivered mill price

mill price

t1t’

We Assume Demand Drops With Price

mill site



demand

mill price

Pattern of Costs, Demand Under Mill Pricing

mill site



demand

mill price

t1t’

Pattern of Margins, Demand Under Mill Pricing

mill site



demand

mill price

t1t’


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Now, Let Us Evaluate ELP-

• Every Customer Pays The Same Delivered Price

Pattern of Margins, Demand Under Uniform Pricing

mill site



demand

mill price

t1t’

Uniform Price

Uniform Demand

Pattern of Costs, Demand Under Uniform Pricing

mill site



demand

mill price

t1t’


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Profits Increase With Uniform Pricing

• Further Opportunities Due To– Optimization of Plant/Warehouse Locations– Avoidance of Product Diversion to Other

Channels/Customers


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Case Study III: Home Banking Services

• Banks Have The Opportunity Of A New Distribution Channel


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Opportunity of New Distribution Channels

• Reduces Bank Long Term Cost

• Increases Service Level To Some Segments and Allows New Products That This Segment Favors

• Threat Potential Entry By E-Banks Sidestepping Traditional Retail Banking


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Creation of Pricing and Segmentation Strategies For

Home Banking Is A Key Issue

• This Is Also A Key Issue For Many Firms Selling Products Into Supply Chains

• Especially Supply Chains That The Firm Does Not Have Control Over

Table: Segmentation of Bank CustomersHigh-Profit Caut ious Professional Homet own

Balances High High Med/ Low Med/ LowBranch-basedt ransactions

Low/M ed high Low High

Usage ofelect ronicsystems (ATM,direct deposit ,etc ...)

Med/H igh Low High Low

Usage of fee-generatingservices

High Low Med/H igh Low

Profitability High Marginal High/M edium Unprof it able

Segmentation Is A Key Issue

• Example of Segmentation Model:


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A Model of Bank Distribution System Design

• Two Segments – E (Disposed To Electronic Distribution)– B (More Comfortable With Branch Based)

• Two Distribution Channels:

–e- Electronic Distribution

–b-Branch or ATM Distribution

Each Segment Values Distribution Channel Differently

• Utility of e by B = - Price(e)

• Utility of b by E = - Price(b)- travel cost*distance

• Utility of b by B = - Price(b) - travel cost*distance

• Utility of e by E = - Price(e)

RBeUB

e

UEb RE

b

UBb RB

b

UEe RE

e

Individual Rationality

• Customers Are Offered Services By Non-Bank Providers

• Net Utility To Customer Must Exceed This Utility:

Max(UEb ,UE

e ) ≥ UE

Max(UBb ,UB

e ) ≥ UB

Incentive Compatibility

• If Branch and Electronic Services Are Offered, – Then Pricing Decisions Must Induce The

Segments To Purchase The Appropriate Product:

UEe ≥ UE

b

UBb ≥ UB

e


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Profit Maximization and Market Entry

• Banks Decide on Branch Locations

• Banks Decide Whether to Offer Branch and Electronic Services, and Their Prices

• Bank’s Objective Is To Maximize Profit

• There Will Be Entry and Expansion Into The Market So Long As Profit Opportunity Exists


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We Seek To Find The Equilibrium Number and Type of

Banks Assuming:

• Profit Maximizing Behavior

• Incentive Compatibility and Individual Rationality of Customers

• Free Entry

Results

• Industry Channel Choice– Considering Cost/Transaction

Electronic

Mixed

0.5 0.75 10.25

0.25

0.5

0.75

1

1.25

1.5

1,75

2

2.25

2.5

ce

cb

2.75

3

Thisregion notallowed inmodel


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Mixed Delivery System Blocks Entry

• A Prediction of the Model Is That E-Banks Will Not Succeed


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Avenues For Further Research

• Explore the Impact of Partition of Decisions on Inventory/Capacity /Stocking Locations on Chain Performance

• Empirical Research on Use of Uniform Pricing

• Further Exploration of Channel Pricing Models Considering IR/IC

Pricing and Supply Chain Management in Electronic Commerce

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