Retail Therapy

How retailers and manufacturers can collaborate to boost profits

Think that supply chain modeling has little to do with your daily life? Think again. Supply chains are practically everywhere—from the toothpaste you buy at Costco or Walgreen’s to the car that you haggle over at the dealership.

In a traditional supply chain, manufacturers and retailers have competing interests. Manufacturers prefer high wholesale prices, while retailers prefer low ones. Such conflict can lead to price wars that undermine the profits of the two groups. Research by Susan Li, Ph.D., a professor at the Robert B. Willumstad School of Business, shows, by contrast, that cooperation between wholesalers and retailers can yield bigger profits for both.

Dr. Li has long applied her expertise in information systems and business modeling to understand how for-profit and not-for-profit organizations can optimize their efficiencies. In a recent study published in the Encyclopedia of Business Analytics and Optimization, Dr. Li and her collaborators used game theory to show how a manufacturer and a retailer can work together to create an advertising strategy and set a final product price and, in so doing, maximize their gains.

Dr. Li and her colleagues incorporated into their model a key factor: reference price. The reference price is the amount that consumers expect to pay for a good or service based on its assumed features and the prices of similar items or services.

“A firm can form a higher reference price in the minds of consumers via various marketing mixes, among which advertising and pricing are the most important ones,” Dr. Li and her co-authors wrote. “Generally, advertising that aims at building up brand awareness can form a higher reference price whereas a price discount leads to a lower one.”

According to Dr. Li and her colleagues, this conflict between advertising that raises the reference price and discount pricing that lowers it is rarely examined in scholarly papers. By considering the impact of reference price on the joint advertising and pricing strategy of a manufacturer and a retailer, Dr. Li and her collaborators offered a new framework for understanding how to create efficient and profitable supply chains.