Near-Optimal Pricing and Replenishment Strategies for a Retail/Distribution System

Abstract

This paper integrates pricing and replenishment decisions for the following prototypical two-echelon distribution system with deterministic demands. A supplier distributes a single product to multiple retailers, who in turn sell it to consumers. The retailers serve geographically dispersed, heterogeneous markets. The demand in each retail market arrives continuously at a constant rate, which is a general decreasing function of the retail price in the market. The supplier replenishes its inventory through orders (purchases, production runs) from a source with ample capacity. The retailers replenish their inventories from the supplier. We develop efficient algorithms to determine optimal pricing and replenishment strategies for the following three channel structures. The first is the vertically integrated channel, where the system-wide pricing and replenishment strategies are determined by a central planner whose objective is to maximize the system-wide profits. The second structure is that of a vertically integrated channel in which pricing and operational decisions are made sequentially by separate functional departments. The third channel structure is decentralized, i.e., the supplier and the retailers are independent, profit-maximizing firms with the supplier acting as a Stackelberg game leader. We apply our algorithms to a set of numerical examples to quantify the supply chain inefficiencies due to functional segregation or uncoordinated decision making in a decentralized channel. We also gain insight into systematic differences in the associated pricing and operational patterns.