Practical and effective contracts for the dominant retailer of a newsvendor product with price-sensitive demand

Abstract

A manufacturer supplies a newsvendor product to a dominant retailer, who does not know the manufacturers unit production cost k. The expected retail demand is a function of the unit retail price p. For this increasingly prevalent but rarely analyzed scenario, we compare the performance of several promising contract formats, including two new contract formats designed explicitly for a dominant retailer to implement, namely: (i) a retailer-implemented two-part tariffs where the retailer charges an upfront lump sum fee besides a fixed percentage markup over any given unit wholesale price, and (ii) a retailer-implemented volume discount scheme. We show that these two new formats perform substantially better than the currently-used practical formats. Thus, they form a basis for a dominant retailer to design a practical and effective purchase contract that approaches the power of the theoretically-optimal but impractical menu of contracts. © 2012 Elsevier B.V. All rights reserved.