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Cutting out the middleman isn’t always best for the consumer

by Robert Preer, Freelance Writer

November 9, 2009

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The Internet and other information technologies have complicated the relationship between manufacturers and retailers. Whereas the traditional distribution model had four levels – manufacturer, wholesaler, retailer, consumer – many manufacturers now sell directly to consumers. Apple, Nike and Hewlett-Packard are among the companies that have adopted the strategy, which can expand markets and give manufacturers control over product price and selection.

But the approach has drawbacks. Retailers see direct-to-consumer as a competitive threat. And to the extent that the strategy does promote competition, it lowers profits for both retailers and manufacturers.   

Daewon Sun and Xuying Zhao, assistant management professors at the Mendoza College of Business at the University of Notre Dame, and Jennifer K. Ryan of Rensselaer Polytechnic Institute, examined this problem and offered solutions in their paper, "Coordinating a Supply Chain with a Manufacturer-Owned Online Channel: A Dual Channel Model under Price Competition," which won the 2009 eBusiness Best Paper Award from the Institute for Operations Research and the Management Sciences (INFORMS). The institute  is the largest professional society in the world for professionals in the field of operations research.

The researchers developed a game-theoretic model to explain how dual channel systems work. The model demonstrates that such systems are rife with inefficiencies, which cut profits for all involved and mean higher prices for consumers.

By characterizing the primary causes of the inefficiencies, the researchers also were able to identify how to avoid problems. Their solution: two types of agreements signed in advance by the manufacturer and retailer to share either revenues or profits and losses. Such contracts will bring higher profits to retailers and manufacturers, and by wringing inefficiencies from the system, lower prices to consumers, according to the researchers.

"These contracts improve social welfare," said Sun. "It is really a win-win-win."

Sun said that the real world is more complicated than an academic model. He suggests that the model be viewed as a guide and not a blueprint.

"Practitioners can consider these options when they try to remove inefficiencies from dual channel supply chains," he said.

Professor Sun’s primary research interests are in pricing strategies and resource management, including economics of information systems, interface between operation management and marketing, contingency pricing strategies for Internet networking, decision support techniques, and pricing strategies in online retailing. Contact Daewon Sun at (574) 631-0982 or dsun@nd.edu.

Professor Xuying Zhao conducts research on supply chain management and service operations management. In recent papers, she has investigated theoretical models of channel competition and coordination; advance selling strategy; time based competition in service industry; inventory management with limited demand information. Contact Xuying Zhao at (574) 631-9061 or xzhao1@nd.edu.