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When Gray Markets Have Silver Linings: All-Unit Discounts, Gray Markets and Channel Management

Manufacturing & Service Operations Management, 2013, 15(2), 250–262

33 Pages Posted: 2 Sep 2010 Last revised: 11 Aug 2013

Ming Hu

University of Toronto - Rotman School of Management

Michael Pavlin

Wilfrid Laurier University - School of Business & Economics

Mengze Shi

University of Toronto - Rotman School of Management

Date Written: August 26, 2012

Abstract

Gray markets are unauthorized channels of distribution for a supplier’s authentic products. We study a distribution channel that consists of a supplier who offers all-unit quantity discounts for batch orders to enjoy cost savings, and a reseller who may divert some goods to the gray markets. We show that the impact of gray markets depends on the reseller’s inventory holding cost. When the reseller’s inventory holding cost is high, diversion to the gray markets improves the channel performance by enabling the reseller to make batch orders. Since the reseller’s order costs decrease through quantity discounts, diversion to the gray markets reduces the resale price and expands sales to the authorized channel. On the other hand, when the reseller’s inventory holding cost is low, the reseller would make the batch orders even without the gray markets. In this case the diversion to the gray markets may improve the reseller’s performance by shortening the order cycles and reducing the inventory holding costs. Interestingly, since diversion to the gray markets decreases the reseller’s cycle inventory volume, the reseller has the reduced incentive to push its inventory and, consequently, the resale price rises and sales volume decreases in the authorized channel. Moreover, there exists a range of reseller’s inventory holding cost and supplier’s cost of scale economy such that it is optimal for the supplier to induce reseller’s gray market diversion through an all-unit discount. We show that these results are robust when the gray market overlaps with the authorized channel or when the gray market price is sensitive to reseller’s diversion volume.

Keywords: gray markets, channel management, inventory, quantity discounts, supplier pricing

Suggested Citation

Hu, Ming and Pavlin, Michael and Shi, Mengze, When Gray Markets Have Silver Linings: All-Unit Discounts, Gray Markets and Channel Management (August 26, 2012). Manufacturing & Service Operations Management, 2013, 15(2), 250–262. Available at SSRN: https://ssrn.com/abstract=1663496 or http://dx.doi.org/10.2139/ssrn.1663496

Ming Hu

University of Toronto - Rotman School of Management ( email )

105 St. George st
Toronto, ON M5S 3E6
Canada
416-946-5207 (Phone)

HOME PAGE: http://ming.hu

Michael Pavlin (Contact Author)

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
CANADA

Mengze Shi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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