2010 International Conference on E-Business and E-Government

Supply Chain Coordination by Revenue Sharing

based on Continuous Quantity Discount Function
Wenfang Shang

Ming Qi

School of Economics and Commerce

South China University of Technology
Guangzhou, China
wenfangshang@139.com

School of Economics and Commerce

South China University of Technology
Guangzhou, China
csmqi@163.net
The recent published studies about RS contracts are as
follows, and they mainly involve the following categories.
First, it is about how the revenue is shared and what the
determining parameters are, for example, the contract may be
related closely with the wholesale price (Cachon and
Lariviere, 2000; Giannoccaro and Pontrandolfo, 2004), or has
a close relationship with inventory level (Gupta and
Weerawat, 2006), or is about sharing the profit proportional to
the risk (Chauhan and Proth, 2005), or about profit sharing
according to the investment amount (Jaberand Osman, 2006),
or related with monetary bargaining space (Hou et al., 2009).
Second, it is about the utilities of RS contracts. Cachon
and Lariviere (2005) compare RS to a number of other SC
contracts and find that RS is equivalent to buybacks in the
newsvendor case and equivalent to price discounts in the
price-setting newsvendor case, and demonstrate that RS also
coordinates a SC with retailers competing in quantities but
does not coordinate a SC with demand that depends on costly
retail effort. Linh and Hong (2009) studies RS contract
between a single retailer and a single wholesaler in a twoperiod newsboy problem and find that the proposed RS
contract has more flexibility than price protection, in that the
optimal RS ratio can be settled reasonably through negotiation
between the retailer and wholesaler.
Third, it is about the implementation issues of the RS
contracts. Wang and Gerchak (2003) and Gerchak and Wang
(2004) consider using RS contracts to coordinate assembly
systems. Giannoccaro and Pontrandolfo (2009) model the
negotiation process among the SC actors by adopting agentbased simulation.
RS contracts in the above literature are always related with
a wholesale price, which is set by the supplier and has no
explicit relationship with market demand or order quantity.
And in the majority of them, RS contracts are always proved
better by comparing the profit of decentralized controlled
scenario under RS contracts with that of centralized controlled
scenario. This paper differs from the existing studies from the
following four aspects.
z We focus on a two-stage SC with a manufacturer and a
distributor, develop a model with each actors profit function,
and propose the new RS contract by finding the common
preference interval, which implies the possibility of
cooperation. Especially, the wholesale price given by the
manufacturer is a continuous linear function about order
quantity.

Abstract This paper investigates the mechanism of revenue

sharing (RS) among the actors in a two-stage supply chain (SC)
with a decentralized decision process. The SC consists of a
manufacturer, and a distributor, and in the chain, profit is
shared proportional to the actors investment amount or effort
level, and sharing profit equally means sharing risk. Whether
they cooperate depends on sensitivity coefficients of market
demand function and quantity discount function. In a numerical
example, the actors common preference interval about profit
fraction is exploited and a new RS contract is proposed, and the
total SC profit and the consumer surplus (CS) with the new
method are proved higher than that in the competitive market
scenario. This paper also implies that direct marketing is of a
higher profit level compared with distribution, however,
transformation of sales mode from distribution into direct
marketing needs gradual transition with the new contract, and
sales mode analyses of Lenovo Company, Dell Company and
Compad Company are provided to illustrate this point.
Keywords- SC, coordination, RS

I.

INTRODUCTION

SC management can be pursued by adopting a centralized

or decentralized control. In the former case, a unique decision
maker exists in the SC, who possesses any information on the
whole SC that is relevant to make decision and the contractual
power to have such decisions be implemented. In the case of
decentralized control, different decision makers exist in the
SC, who pursues their own objectives, which can be
conflicting and lead to system inefficiency. To cope with this
problem, proper coordination mechanisms need to be adopted,
which modify the incentives of the different decision makers,
so as to induce them to maximize the SC total profit.
Numerous models of SC coordination mechanisms have
been developed in the existing literature, which include the
quantity discounts (Weng, 1995), the backup agreements
(Eppen and Iyer, 1997), the buy back or return policies
(Emmons and Gilbert, 1998), the allocation rules (Cachon and
Lariviere, 1999), the quantity flexibility contracts (Tsay,
1999), the incentive mechanisms (Lee and Whang, 1999), and
the RS contracts (Cachon and Lariviere, 2000). Of the existing
contract models, RS contract is relatively simple for design
and administration and has received enormous attention from
many researchers. We herein also focus on the RS contracts.

978-0-7695-3997-3/10 $26.00 2010 IEEE

DOI 10.1109/ICEE.2010.1324

5287

To be identified easily, we add to differ the optimal

solutions from the informal expressions.
Assumptions
z There are only two actors in the chain, a manufacturer
and a distributor.

z RS contract in this paper essentially includes two basic

implications: one is sharing profit proportional to the
investment amount or effort level in channel development, the
other is sharing risk proportional to the profit.
z The method is proved effective by comparing the total
SC profit and the CS between competitive market scenario and
cooperative scenario, both of which are decentralized
controlled.
z This paper demonstrates that direct marketing is the
sales mode of a higher profit level. Changing sales mode of
distribution into that of direct marketing needs cooperating
with the distributors.
The rest of the paper is organized as follows. Section
describes the notations, assumptions, the three-stage SC
model, and the solution procedure. Section deduces the
new coordination contract. Section introduces a numerical
example to illustrate cooperation between actors is effective,
providing comparison analysis of related indices and
discussion of the results, and finally, the paper summaries and
concludes in Section .
II.

Descriptions
Fig. 1 provides a descriptive diagram of the SC.
B. SC Model
It is familiar with us that the distribution channel profit can
be expressed as ( p c 2 )q , however, distribution channel
is occupied by not only the distributor but the manufacturer,
thus, the profit is shared by both of them, and the profit
proportion is 1 and respectively. However, the
manufacturer also earns profit from production, written
as ( c1 )q . Based on the analysis, the profit function of the
distributor and the manufacturer are as below.
D = (1 )( p c 2 )q
(1)
M = ( p c 2 )q + ( c1 )q
(2)
Actors in our model are risk takers and therefore the profit
fraction also means risk proportion and investment amount or
effort level.

THE MODEL

A. Model notations, assumptions, and descriptions

Notations
Manufacturers production cost for unit
c1
product
c2
Distributors distribution cost for unit product
Distribution price of unit product offered by
p
the distributor
Preliminary wholesale price of unit product
0
offered by the manufacturer
q
Market demand induced by the consumers
= 0 kq Continuous quantity discount function
p = a bq
Inverse demand function
Manufacturers profit fraction of distribution

channel profit
Distributors profit function with market
D (q)
demand quantity q
Manufacturers profit function with market
M (q)
demand quantity q
Distributors profit function with RS
D ( )
coefficient
Manufacturers profit function with RS
M ( )
coefficient
CS
Consumer surplus

Manufacturer
c1
= 0 kq

The SC is decentralized controlled, following a leaderfollower scheme, which means the manufacturer is
assumed to be the leader, and the distributor is the
follower. The decision process between them is a
Stackberg game.

C. Solution to the model

The leaderfollower scheme essentially implies that the SC
member as the leader has the power of influencing another
members decisions. In this paper, the manufacturer first
offers preliminary wholesale price of unit product 0 , the
distributor orders q units products and takes a price
of = 0 kq and offers the distribution price p . Definitely,
the leader has to allow for the followers possible reaction as
determining the price.
Thus, to get the optimal solution to the model, we need to
consider the distributors profit function first, assuming 0 has
been known. Eqs. (4) shows that the profit function is strictly
concave and can achieve its maximum. Let the functions
first-order derivative in Eqs. (3) equal zero and we can get the
optimal order quantity as in Eqs. (5), an expression with 0 .
D q = a 0 c 2 2(b k )q
(3)

2 D q 2 = 2(b k ) < 0

Distributor
c2

p
p = a bq

Consumers
q

Distribution channel profit

Production profit

( M , D ) ( ,1 )

Fig.1. Diagram of the two-stage SC

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(4)

a 0 c2
(5)
2(b k )
By substituting it into the manufacturers profit function,
we use the same method as the above, and get the final result
of 0 in the following equation.
[b(1 ) + k ](a c 2 ) + (b k )c 1
0 =
(6)
(2 )b + ( 1)k
Integrate Eqs. (5) and (6) and we can get the final optimal
order quantity in Eqs. (7).
a c1 c 2
q =
(7)
2[(2 )b + ( 1)k ]
Thus,
with
the
final
optimal
solutions
of 0 and q substituted into the profit functions of each actors,
q=

define R = (a c1 c 2 ) 2 / 4 and then the profits can be

expressed as follows.
(1 )(b k )
(8)
R
D =
[( 2 )b + ( 1)k ] 2
1
R
(9)
M =
(2 )b + ( 1)k
The CS can be also computed, as in Fig. 2 and Eqs. (10).
R
CS =
(10)
2[(2 )b + ( 1)k ] 2

CS

q
q

(b k ) 2 [2b( + 1) + 2k (1 )]

R < 0 (12)
2
[( 2 )b + ( 1)k ] 4
Applying intermediate value theorem (Apostol, 2007), we
can find that [0,1] satisfies Eqs. (13) and denote it as 1 .
Thus, the distributors preference interval is [0, 1 ] .

D
(b k )[b + (1 )k ]
=
R

[(2 )b + ( 1)k ]3
(13)
2
0 (b k ) R /(2b k )
=
1 0
Secondly, we use the same method to exploit the
manufacturers preference interval. The first-order and
second-order derivatives of the profit function are as in Eqs.
(14) and (15), which suggest the function is a monotone
increasing function. In the interval [0,1] , its maximum and
minimum values are R b and R (2b k ) , respectively.
M
bk
=
R>0

[(2 )b + ( 1)k ] 2
2 M

(14)

2(b k ) 2

R>0
(15)
2
[( 2 )b + ( 1)k ] 3
Similarly, applying intermediate value theorem, we can
find that [0,1] satisfies Eqs. (16) and denote it as 2 .
Thus, the manufacturers preference interval is [ 2 ,1] .

M
bk
=
R

[(2 )b + ( 1)k ]2
(16)
R b R (2b k )
=
1 0
Thirdly, we discuss how to get the common preference
interval and the RS parameter. The relationship
between 1 and 2 may be as the following descriptions.
Case 1: If 1 < 2 , [0, 1 ] [ 2 ,1] = and it is impossible
to cooperate with each other.

2 D

ab

Profits

Fig. 2 Diagram of the CS

III.

COMMON PREFERENCE INTERVAL

Coordination through RS contract is a basic strategy and

applicable in a wide range of situations. One key problem is
how to determine the RS fraction for bigger coordination
opportunities as well as for higher achievement levels of
profit. Next, we focus on finding the actors common
preference interval with the following steps.
Firstly, in order to exploit the distributors preference
interval, we analyze its profit function through the first-order
and second-order derivatives, and its a monotone decreasing
function according to Eqs. (11) and (12). In the interval [0,1] ,
the
values
of
maximum
and
minimum
are
2
are (b k ) R /( 2b k ) and 0 , respectively.
D
(b k )[b + (1 )k ]
R<0
=

[(2 )b + ( 1)k ] 3

(11)

D
Distributors preference interval
0

Manufacturers preference interval

Fig.3. Preference intervals of the
manufacturer and the distributor

Case 2: If 1 > 2 , [0, 1 ] [2 ,1] = [2 , 1 ] thus, the

manufacturer and the distributor can cooperate by choosing a

5289

profit fraction [2 , 1 ] . That is to say, their common

preference interval is [ 2 , 1 ] , as the specific description in
Fig.1.
In fact, the relationship between 1 and 2 depends on the
parameters of b and k . Whether the actors can cooperate
depends on the sensitivity coefficients of the market demand
function and quantity discount function.
IV.

APPLICATION WITH A NUMERICAL EXAMPLE

One of the key issues in a SC is its efficient coordination

with objectives of customer satisfaction and sustaining
competency. In this section, we clarify the proposed RS model
by a numerical example. We also verify that the proposed
model can help increase the total SC profit and the CS, by
supporting an appropriate choice of the contract parameter.
The assumed problem data is b = 3 and k = 2 . By
substituting b = 3 and k = 2 into Eqs. (13) and (16), we can get
the following equations with 1 and 2 .

13 1212 + 641 32 = 0

(17)

7(4 2 ) = 288
(18)
The solutions are 1 = 0.5551 and 2 = 0.536 respectively,
thus, their preference interval is [ 2 , 1 ] = [0.536,0.5551] , and
we can choose = 0.54 as the profit fraction of the
manufacturer. Table 1 gives a specific description of the
related indices, and the symbol implies an increasing
function, and implies a decreasing one.

and the CS by 5.6% , compared with those in the competitive

market scenario. Whats more, Table 1 tells us that
cooperation is better than incorporation, however, direct
marketing with = 1 is of the highest profit level. In practice,
all companies develop their own sales modes and try to gain
much more profit.
For example, Lenovo Company has been playing an
important role in the development of distribution channel, e.g.,
the company had implemented ERP system and raised the
efficiency of information exchange between distributors.
Whats more, Lenovo Company always considers the
distributors as business partners, and thus the relationship with
the distributors is correlative dependent especially in interests.
As so far, Lenovo Company has successfully set up its own
distribution channel management system and benefited much
from this.
Dell Company has been adopting direct marketing to
develop business since the very beginning of the companys
establishment. As demonstrated in Table 1, direct marketing is
of a higher profit level, and it has brought fat profit for Dell
Company. It also makes retail price lower and brings much
value for the customers because there is no existence of
distributors.
However, Compaq Company, which had been well-known
for its scale and business before the establishment of Dell
Company, developed sales market through distribution. As
distribution is of a lower profit level, Compaq couldnt catch
up with the late comer Dell, and then the leader tried to adopt
direct marketing instead of distribution. Unfortunately,
channel transformation finished with failure.

The cooperation between the two actors has increased the

manufacturers profit by 15.6% , the total SC profit by 4.64% ,

Indices

D
M
SC profits
CS

Table 1 Profits comparison of the distributor and the manufacturer

=0
= 0.54
Expression
Increment
(competition)
(cooperation)
R 16
0.038R
-39.2%
(1 ) R (4 ) 2
R
4
0.289 R
R (4 )
15.6%

=1
(direct marketing)
0
R3

5R 16

0.327 R

4.64%

R3

R [ 2( 4 ) ]

R 32

0.033R

5.6%

R 18

(5 2 ) R (4 )
2

Manufacturer
0%

Distributor
100%

Competition

Distributor
46.0%

Manufacturer
54.0%

Cooperation
Inadvisable transformation
Fig. 4 Allocation of distribution channel profit

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Distributor
0%

Manufacturer
100%

Direct marketing

All companies are eager to gain fat profit; however,

distribution and direct marketing are quite different sales
mode. Changing sales mode from distribution into direct
marketing without transition is easy to get into trouble. If
channel transformation is implemented gradually, there must
be a different result. Compaq Company didnt realize the big
gap between distribution and direct marketing, and attempting
to finish channel transformation during one night brought
about channel conflicts, which are essentially interest
conflicts. If they choose to cooperate with distributors first, the
conflicts may be depressed and their interests can be increased
with vast scale, then the company would take measures to
gradually occupy the distribution channel and adopt direct
marketing mode finally.
V.

REFERENCES
[1]
[2]

[3]

[4]

[5]
[6]

CONCLUSIONS

[7]

As a matter of fact, hardly any manufacturer would drop

the distribution channel drastically and outsource all products
sale to distributors. Similarly, a manufacturer cannot occupy
the distribution channel solely. In most cases, product sales
need SC actors cooperation; finding out the RS parameter,
which can be accepted by each SC actors, is all-important for
long term development.
In this paper, the model proposed is based on a two-stage
SC, consisting of a manufacturer and a distributor, and
following a leader-follower relationship. Profit is shared
proportional to the actors investment amount or effort level in
channel development. Moreover, the profit fraction also means
the risk share that they need to take. However, whether they
can cooperate depends on the sensitivity coefficients of
demand function and quantity discount function. In section 4,
a numerical example is introduced to illustrate how to choose
an appropriate profit fraction. Comparison of related indices
about the example demonstrates that cooperation is more
efficient than competition; however, direct marketing is
preferred by companies. Nevertheless, changing sales mode of
distribution into that of direct marketing without transition is
inadvisable, and it absolutely needs cooperating first with
distributors under the new RS contract and then occupying the
whole distribution channel by inches until possessing it
completely.
However, we havent discussed the case that there are
multiple actors in a certain stage of the SC, and the case of
three-stage SC, and this represents directions for our future
work.
VI.

[8]

[9]

[10]

[11]

[12]

[13]

[14]

[15]

[16]

[17]

[18]

ACKNOWLEDGEMENTS

This paper is supported by Provincial and Ministerial

Special Fund for Cooperation by Production, Study and
Research of Guangdong Province, China (2009B090200062).

[19]

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