Drop shipping

As Xu et al. (2009) point out, there is always some time delay (as long as several days) between order placement and its shipment. In some cases, customers may choose delayed shipping for a discount. This time delay can be used to make better choices of warehouses for order picking. Xu et al. (2009) have constructed an effective heuristic for assigning customer orders to warehouses that minimizes the total number of shipments. 

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No prequalification is required for vendors who perform simple deliveries or drop ship (i.e., Federal Express, telephone company, bottled water supplier, trash collector, utility companies, supply and material deliveries), and would not involve entrance into an exclusion/contaminated zone. 

After doing the custom frames for six months, and receiving numerous inquiries for specialty components such as titanium axles, RockShock shocks, and specialty handlebars, John began looking for suppliers. He knew from his experience with the frames that he did not want to stock an inventoiy of parts, but he felt that he could still sell components. Initially, he partnered with a small machine shop making titanium turned parts such as axles and hubs. He set up his Web site so that, when ABC received the order and the credit card amount, an order was placed with the machine shop to drop-ship the component to the customer and credit the machine shop s bank account (transaction with customer, transaction with supplier with accompanying information for both). 

After several months, John had created similar relationships with a group of dilferent specialty item makers, but there were still gaps in his component offering. So he sought a different approach and found a multi-line distributor willing to provide a full line of products, including handling (on the same basis John had) the specialty manufacturers. Now when a customer called in and placed an order, it went directly to the distributor, who supplied some of the components from his warehouse, and others were drop-shipped directly from the other suppliers (transaction with customer, with distributor, and with supplier to distributor). 

Netessine, S., N. Rudi. 2000. Supply Chain Structures on the Internet Marketing-Operations Coordination Under Drop-Shipping. Working paper, Wharton School, University of Pennsylvania, Philadelphia, PA. 

Practices such as drop-shipping (Netessine and Rudi 2001(a,b)) separate the selling task from the physical or financial ownership of material, so that the seller becomes essentially an order-taker. For example, a book ordered from Amazon.com might travel directly from the book distributor to the end customer, with activity initiated only after Amazon has assured payment from the customer s credit card company. Monitors in Dell s orders are shipped directly from Sony s warehouses to the end customer without ever passing through Dell-owned facilities. A related development is exemplified by the option for Amazon.com s customers to pick up certain purchases (and make returns later if necessary) at a local Circuit City store, which was introduced in late 2001. 

To the best of our knowledge, this chapter represents the first formal model of a drop-shipping supply chain, the practice where the retailer acquires customers while the wholesaler is responsible for fulfillment and takes inventory risk. We compare traditional supply chain structures in which the retailer both takes inventory risk and acquires customers with supply chain structures employing drop-shipping agreements. Our focus is on the supply chains in which both the retailer and the wholesaler are present. We concentrate on two cost... 

Our main interest in this chapter is to get a better understanding of inventory risk allocation issues in drop-shipping supply chains as well as the impact of power distribution between the channel entities. To keep focus and to not diffuse economic insights, we do not explicitly reflect other issues encountered in e-commerce fulfillment, since many are hard to include in a formal model. Among these issues are possible differences in transportation costs and responsiveness, coordination issues arising when multiple wholesalers are needed to fulfill a single order, and the rationing of inventory when a wholesaler serves multiple retailers. These and other issues are treated qualitatively in Randall et al. (2002). 

The practice of drop-shipping has been described qualitatively in the marketing literature (see Scheel 1990 and references therein, page 7), but, to the best of our knowledge, its distinct features, i.e., the wholesaler taking inven-... 

Superscripts I, T and D will denote vertically integrated, vertically disintegrated (traditional), and drop-shipping supply chains, correspondingly. Further, we will consider three drop-shipping models. In Model DW the wholesaler has channel power, in Model DR the retailer has channel power, and in Model DN the players have equal power. We also assume the following quite general form of the demand distribution ... 

Under a drop-shipping arrangement, the channel members will make their decisions strategically and hence a game-theoretic situation arises. Similar to... 

From part a) of Proposition 6, we see that vertical disintegration leads to underspending on customer acquisition by the retailer, and in drop-shipping models the retailer imderspends more than in the traditional model due to the misalignment of marketing and operations functions. It is interesting to note that... 

In the previous section, we demonstrated that the solutions of Models T and D are generally different from the system-optimal solution. In addition to the double marginalization effect, drop-shipping is also plagued by marketing-operations misalignment. Can we come up with a mechanism that will induce coordination As the next observation shows, a price-only contract is not sufficient. 

Drop-shipping requires a certain investment from the wholesaler, since she should be able to handle small shipments directly to the customer. In addition, there are costs associated with taking inventory risk. This would lead the wholesaler to demand an increase in the wholesale price, resulting in, as the last observation shows, capturing more profits, which is beneficial in the long run. 

Negotiation power does not do the wholesaler much good she is generally better off when the retailer acts as a leader. The wholesaler s expected profit is virtually the same in the traditional channel structure T as in the drop-shipping... 

The drop-shipping model with the powerfixl retailer proves to be superior under moderate to high wholesale prices, as we demonstrated earlier. Under a very high wholesale price, any drop-shipping model outperforms the traditional model. Among the three drop-shipping models, Model DN is consistently the worst, and Model DR is consistently the best. 

Finally, we will illustrate the coordinating contracts. Assume that c = 5, r = 8, and A = 1. We denote profits for the retailer and the wholesaler resulting from the coordinating contract by and correspondingly. As we noted before, a returns contract for the traditional supply chain and a penalty contract for the drop-shipping models splits profits in the same proportions. Figure 14.7 presents retailer s and wholesaler s profits with and without coordination for all models. 

We find simple contracts that achieve coordination in both the traditional supply chain and the supply chain with drop-shipping. According to these contracts, in the traditional channel the wholesaler subsidizes a portion of customer acquisition expenses as well as compensates the retailer for inventory carried over. In the case of drop-shipping inventory compensation goes from the retailer to the wholesaler. If the wholesaler can choose the wholesale price, the proportion of the customer acquisition expenses to subsidize, and the inventory compensation, an arbitrary split of profits can be achieved. In any case, the proportion of profits that the wholesaler captures coincides with the proportion of customer acquisition costs she subsidizes. Therefore, the higher the subsidy, the higher the wholesale price and the higher the wholesaler s profits. 

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