Drop-shipping channel

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). 

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... 

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... 

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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