Ownership Coordination in a Channel: Incentives, Returns, and Negotiations

39 Pages Posted: 17 Nov 2011

See all articles by Eyal Biyalogorsky

Eyal Biyalogorsky

Arison School of Business; Independent

Oded Koenigsberg

London Business School - Department of Marketing

Date Written: 2010

Abstract

In many industries firms have to make quantity decisions before knowing the exact state of demand. In such cases, channel members have to decide which firm will own the units until demand uncertainty is resolved. The decision about who should retain ownership depends on the balance of benefit and risk to each member. Ownership, after all, is costly. Whichever member owns the units accepts the risk of loss if more units are produced than can be sold. But ownership also grants firms the flexibility to respond to demand once it becomes known by adjusting price. In this study, we analyze ownership decisions in distribution channels and how those decisions are affected by demand uncertainty. We model demand based on micromodeling of consumer utility functions and capture demand uncertainty related to market size and price sensitivity. This study shows that as long as the degree of uncertainty about market size is intermediate, the retailer and the manufacturer both benefit when the manufacturer maintains ownership of the units. But when there is substantial uncertainty about market size, the retailer and the channel are better off if the retailer takes ownership but the manufacturer still prefers to maintain ownership. Thus, there is potential for channel conflict regarding ownership under high levels of uncertainty. We show that, using product returns, the manufacturer can achieve the same outcome under retailer ownership as under manufacturer ownership. This provides an additional new rationale for the prevalence of product returns. The first-best outcome (from the perspective of total channel profit), however, is under retailer ownership without product returns when uncertainty is high (i.e., product returns reduce the total channel profit). Negotiations between the manufacturer and the retailer can lead to the first-best outcome but only under quite restrictive constraints that include direct side payments by the retailer to the manufacturer and the retailer being pessimistic about its outside option (when an agreement cannot be reached) during the negotiation.

Suggested Citation

Biyalogorsky, Eyal and Koenigsberg, Oded, Ownership Coordination in a Channel: Incentives, Returns, and Negotiations (2010). Available at SSRN: https://ssrn.com/abstract=1960267 or http://dx.doi.org/10.2139/ssrn.1960267

Eyal Biyalogorsky

Arison School of Business ( email )

P.O. Box 167
Herzliya, 46150
Israel

Independent ( email )

No Address Available

Oded Koenigsberg (Contact Author)

London Business School - Department of Marketing ( email )

Sussex Place
Regent's Park
London, NW1 4SA
United Kingdom

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