Individual Supplier Behavior and the Effectiveness of Revenue Sharing and Wholesale Contracts: A Behavioral Study

Abstract:     
Using a behavioral laboratory approach, we investigate how a supplier’s individual differences, such as risk aversion and fairness concerns, influence how they set the pricing parameters of a wholesale or revenue sharing contract. For each contract we consider both a weak retailer who accepts any contract with positive expected profit and a strong retailer who is able to set a minimum acceptable profit and reject unsatisfactory contracts. We find that in the revenue sharing contract, risk aversion reduces system efficiency as suppliers instead move toward risk-free wholesale price contracts. Absent rejection risk, suppliers with higher concerns for fairness allocate increased shares to the retailer and this preference mitigates risk aversion to improve system efficiency. The retailer’s right to reject unfavorable contracts improves retailer profit and system efficiency subject to the amount of rejection risk a supplier willingly incurs. Given a strong retailer or a fairness-minded supplier the simple wholesale price contract is comparably efficient to the revenue sharing contract set by a risk-neutral supplier and we find the coordinating contract is unnecessary. Conversely, given a strongly risk-averse supplier with no concerns for fairness a revenue sharing contract is comparable to the wholesale contract and is ineffective in overcoming double marginalization.

Number of Pages in PDF File: 32

Keywords: supply chain coordination, behavioral operations, behavior, wholesale, revenue sharing, experimental

working papers series