MOBILE SERVICE SUPPLY COORDINATION WITH REVENUE SHARING CONTRACTS

Yaobin Lu luyb@mail.hust.edu.cn Jiabao Lin ljb0916@smail.hust.edu.cn School of Management Huazhong University of Science and Technology Wuhan 430074, China Phone: +86 27 87558100 Bin Wang binwang@utpa.edu College of Business Administration University of Texas-Pan American Edinburg, TX 78539, USA Phone: +1 956 3813336 Abstract: Different from the traditional supply chain, the mobile service supply chain has its unique characteristics. This research studies the coordination mechanism of the mobile services supply chain, and establishes and analyzes a model of revenue sharing contract. We prove that under certain conditions, the revenue sharing contract can achieve the maximization of expected profit and coordination of mobile services supply chain. We also validate the effectiveness of the model using a numerical example. Key words: mobile service, coordination of supply chain, sharing revenue, contract 1. Introduction Mobile commerce is the various commercial information exchange and business activities conducted on mobile communication networks using the terminal equipments of mobile communication (mobile phonespersonal digital assistants and so on) (Yuan 2006). Now there are many mobile services such as Fetion, Multimedia Message Service (MMS), game, ticket and mobile payment in China. The fields of mobile services include entertainments, news, tourism, finance, insurance and so on . There are many services and a large number of consumers. Thus it is difficult to deal with allocation of profit between the mobile network operator (MNO) and other members, which brings the problem of how to carry out the optimal distribution. As the most powerful firm in the mobile service supply chains, the

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mobile network operator not only creates most profit for itself, but also needs to consider optimizing and coordinating the mobile service supply chain. Therefore, we think it is important to conduct a study of profit allocation, considering the mobile operator as a central member of the mobile service supply chain. The content/service provider (CP) is the party most related to the MNO that uses the network platform of the MNO to supply consumers with many kinds of services. Thus without it the network platform will be nothing. In turn, without the network platform of MNO, CP cannot directly pass the services to consumers even if they are very good and need to survive depending on the mobile network operator. It indicates that the relationship between CP and MNO is closely collaborative and complementary. At present, as the creator of information and service, the CP becomes more and more important in the mobile service supply chain. Therefore, we construct a two-stage mobile services supply chain composed of one MNO and one CP and designed a coordinating revenue sharing contract to analyze optimization and coordination of mobile service supply chain. The paper is organized as follows: In Section 2 we review previous work on revenue sharing contracts. In Section 3 the key features of mobile service supply chain are discussed. In Sections 4 and 5 we define the model and derive our findings. A numerical illustration is provided in Section 6. The paper ends with some conclusion and policy implications. 2. Related literature Supply Chain Management (SCM) refers to the use of a total system approach to manage the flow of materials, information and service to fulfill the customers demand. Now, research on SCM has been gaining traction (e.g., (Shapiro 1984; Houlihan 1985) )and the focus is on the coordination, optimization and recombination of the supply chain. The coordination of the supply chain includes the coordination between manufacturers and suppliers, between manufacturers and retailers, and the coordination of internal activities among manufacturers, suppliers and retailers. The supply chain system has both centralized and decentralized models. A centralized supply chain system views the supply chain as one entity that possess all the information on the whole chain related to decision making, which allows the optimization of supply chain performance. The centralized control assures system efficiency, but it is rarely realistic. In a decentralized supply chain system, there are several self-concerned profit maximizing members. So it is difficult to optimize the revenue of the whole supply chain. As a result, coordination mechanisms are necessary so as to have decision-makers pursue channel coordination. Supply chain contract is one of the most important coordination mechanisms. It refers to the provision of appropriate information and incentive measures to assure both buyer and seller coordination and optimization of the sale channel. In a word, supply chain contract utilizes incentives to make supply chain actors decisions coherent. In particular, the incentives allow the risk and the revenue be shared by all supply chain partners. Therefore, supply chain contracts have two main objectives. First, it increases the total supply chain profit and achieves a profit that is close to the

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one under a centralized control. Second, it allows risk sharing among the supply chain participants(Tasy 1999). In 1985, Pasternack(1985) firstly proposed the concept of supply chain contract. Ever since then researchers have examined supply chain contracts extensively(Cachon and Larviere 2002). Supply chain models mainly include revenue sharing contracts, quantity flexibility contracts, buy back contracts, and the wholesale price contracts. The wholesale price contracts and the buy back contracts are firstly studied and also are the most common contracts. Moreover, they respectively embody the core contents of supply chain: member revenue and product quantity. Others contracts such as the quantity discount contract and the sale rebate contract evolved from the four basic contracts. Revenue sharing contract is a coordinating mechanism where a retailer pays a supplier with a low wholesale price for each unit purchased, plus a percentage of the revenue the retailer generates. Such contract has become prevalent in the videocassette rental industry. A typical case is Blockbuster, a movie rental firm. In a conventional sale agreement, Blockbuster purchases each tape from its supplier for $65 and charges about $3 per rental. As a result, the breakeven point is at 22 rentals. However, because the demand for a movie is usually high when it is new on tape and diminishes very quickly, Blockbuster doesnt have the incentive to purchase a large enough number of tapes to meet the initial high demand. To solve this problem, in 1998, Blockbuster started paying its suppliers a portion (50%) of its rental income so as to get a lower wholesale price of $8. Under this situation, the break-even point for a tape dropped to approximately six rentals, enabling Blockbuster to purchase more tapes to meet initial demand. Blockbusters market share of video rentals climbed from 24% in 1997 to 40% in 2002. There are several theoretical and empirical studies of revenue sharing contracts. Mortimer (2000) studied revenue sharing contracts and found that they increased an industrys total profit by 7%. Dana and Spier (2001) considered a supply chain with competitive retailers and stochastic demand. They derived optimal revenue sharing. Recently, Veen and Venugopal (2005) examined a simple twolevel supply chain that was composed of a movie studio and a video rental shop. In particular, they contrasted three different mechanisms and proposed that revenue sharing contract could optimize the chain and bring win-win situation to the players in the industry. Cachon and Lariviere (2005) studied revenue sharing contract in a general supply chain model with revenue determined by each retailers purchase quantity and price. They identified its strengths and limitations. The effectiveness of revenue sharing was compared with other coordination mechanisms such as buy-back contracts and price-discount contracts. Demirkan and Cheng (2006) studied a supply chain composed of one application service provider (ASP) and one application infrastructure provider (AIP). They examined the supply chains performance under different coordination strategies involving risk and information sharing between the ASP and the AIP. Recently, Ilaria and Pierpaolo (2004) proposed a model of revenue sharing contracts aiming at coordinating a three-stage supply chain. The above literatures mainly address the problem of coordinating supply chain made up of two stages. Moreover, most of them study product supply chain not service supply chain.

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Little literatures involve the coordination of service supply chain that provides service. In this paper, we develop a revenue sharing contract model to examine the coordination of the mobile supply chain. 3. Mobile service supply chain As one of service supply chains, the mobile service supply chain has the following properties. First, this supply chain provides customers with service products that can not be physically stored. Thus, there is no service inventory being produced and stored ahead of schedule. Therefore, in the mobile service supply chain, CP and MNO are inevitably pulled by demand, which is obviously different from the traditional supply chain that only has partly pull periods. Second, mobile service products are technological network products. The process of passing products from the CP to the MNO is also that of manufacturing and selling them. The MNO can manufacture products as long as the network is available. If the network capacity is large but there are not enough customer demand, the overstock of mobile services will arise. In addition, the order quantity is continuous in traditional supply chain. But the sunk network capacity is only a series of discrete value in mobile service supply chain. Third, usually, the services that the CP produces are information goods. One of the most fundamental features of information goods is that the cost of production is determined by the first-copy costs. Once the first copy of the information has been produced, additional copies cost is approaching zero. In other words, the cost of production is relatively stable no matter how much information goods were produced. Fourth, the mobile service supply chain is much more unstable than the traditional supply chain owing to diversity and unpredictability of the service demand. Therefore, different from the research on traditional supply chain, we need to introduce new propositions and consider the simultaneity of passing products and manufacturing products in mobile service supply chain. Can revenue sharing contract optimize the profit of mobile service supply chain? How does the contract achieve optimal distribution of profit between CP and MNO? What is the optimal proportion of distribution? These questions are related with all parties in service supply chain. So we analyze the coordinating mechanism of mobile service supply chain in the context of some entertainment services. 4. Model and propositions We consider a two-level mobile service supply chain that is composed of one mobile network operator (MNO) and one Content/Service Provider (CP). In this supply chain, the CP rents the MNOs network capacity to pass information goods from itself to the MNO at a unit price . The CP sells information goods that are produced by itself to customers at a unit price p. The sales revenue is first obtained by the MNO, and then the sale revenue is distributed between the MNO and CP (Lu Yaobin et al. 2007). The research model is shown in Figure 1.

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CP Content Provider content fund

actor service/information flow fund flow possible condition p MNO service service

Service Provider

customer

Figure 1. The mobile service supply chain We outline basic assumptions of the model as follows: 1 For the model, we just consider one given sale period N in which the network is capacity qi i = 1, 2... n a series of discrete value. The fixed cost is denoted by c m i i = 1, 2... nin different network capacity qi i = 1, 2... n. 2 Sale price of per unit service is p . The service demand that correlates with service price p is a random variable denoted by D ( P ) . F ( x, p ) denotes the distribution and f ( x, p) denotes the density function of demand( x 0 ). We

assume that F ( x, p) is twice differentiable and

F ( x, p ) > 0 for every p . p

3 c0 denotes the MNOs per unit variable cost of service. Usually the variable

cost is very small. For example, the variable cost of passing a SMS is by 0.01 RMB, but the quantity of service is large, so the variable cost is needed. 4 The variable cost of the CP for per unit service and the fixed cost of the CP are respectively denoted by cs 2 and cs1 .
5 (0 1) is the quota of the MNOs revenue that the MNO keeps while

giving the rest ( 1 ) to the CP. Let S (qi , p) be expected sales, S ( q i , p ) = E {min( q i , D ( p ))} = m in ( q i , x ) f
0

( x, p )dx

= q i (1 F ( q i , p )) +
= qi

qi 0

xF ( x, p )dx

qi 0

F ( x, p )dx

Under the revenue sharing contract, the MNOs profit function is

(qi , p ) = p S (qi , p ) + S (qi , p ) c0 S (qi , p ) cmi

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the CPs profit function is

s ( q i , p ) = (1 ) pS ( q i , p ) S ( q i , p ) c s 2 S ( q i , p ) c s 1

and the supply chains profit function is

( q i , p ) = p S ( q i , p ) ( c 0 + c s 2 ) S ( q i , p ) c s1 c m i

5. Supply chain coordination In this section, we consider optimizing and coordinating the mobile service supply chain. From equation4, we can find that:
qi qi F ( x , p ) ( qi , p ) = qi F ( x , p ) dx ( p c0 c s 2 ) dx 0 0 p p
2 qi F ( x , p ) qi F ( x , p ) 2 (qi , p ) = (2 d x + ( p c0 cs 2 ) dx) 0 0 p 2 p p 2

5 6

Under certain conditions, the function (qi , p ) has a maximum.

Proposition 1. For a given network capacity qi , there exists a unique optimal price

pi* that maximizes the supply chains profit function (qi , p ) when p c0 + cs 2 and
2 F ( x, p ) 0. p 2
2 Proof: Based on p c0 + cs 2 F ( x , p ) 0 we can prove that 2

2 qi F ( x , p ) qi F ( x , p ) 2 ( qi , p ) = (2 dx + ( p c0 cs 2 ) dx ) 0 . 0 0 p 2 p p 2

Therefore , the supply chains profit function (qi , p ) is concave and diminishing in sale price p ( p [c0 + cs 2 , ] ). When p = c0 + cs 2 , we find that
qi (qi , p) = qi F ( x, p)dx 0 0 p

(qi , p) is p

(7)

F ( x, p) 2 F ( x, p ) 0. is increasing in sale price p owing to p 2 p Thereforewhen p2 > c0 + cs 2 ,we find that

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qi

F ( x , p ) | p = p2 dx > p

qi

q F ( x , p ) | p = c0 + cs 2 dx = M p2 > c0 + cs 2 + i M p

qi qi F ( x , p ) ( qi , p ) | p = p2 = qi F ( x , p ) dx ( p2 c0 cs 2 ) | p = p2 dx 0 0 p p

qi ( p c0 c s 2 )
< qi qi M =0 M

qi

F ( x , p ) | p = p2 d x p

(8)

From7and8, for a given network capacity qi there exists a unique pi* to cause
(qi , p) | p = p* = 0 .Therefore, pi* is the optimal solution to the problem max (qi , p ) . i p

From Proposition 1, we know that there exists a unique optimal price pi* that maximizes the supply chains profit for different network capacity qi . When the supply chains profit is maximized, can revenue sharing contract coordinate the MNO and the CP? We will answer this question in Proposition 2. Let

(qi , pi* ) = max (qi , p) .

Proposition 2.

With

revenue

sharing

contract,

when = (1 )c0 cs 2 , = cmi /(cs1 + cmi ) , the MNOs profit function and the CPs profit function are respectively m ( q i , p ) = ( q i , p ) and s ( q i , p ) = (1 ) ( q i , p ) and qi , pi* } simultaneously makes the MNOs profit and the CPs profit maximized.
Proof:
i * i

Given

the

profit

function m ( q i , p ) = ( q i , p ) ,
m

it

follows

that

{q , p } maximizes the MNOs profit when > 0 . To obtain

profit function follows from

( qi , p ) = ( qi , p ) ,

substitute = (1 )c0 cs 2 and = cmi /(cs1 + cmi ) into (2) and simplify. The CPs
m ( qi , p ) = ( qi , p )

and

s (qi , p ) = (qi , p ) m (qi , p ) . W Proposition 2 indicates that is the MNOs share of mobile service supply chains profit in additional to its share of revenue. Thus, revenue sharing contract

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coordinates the supply chain. In addition, revenue sharing coefficient merely correlates with the MNOs and the CPs fixed cost and has no relation to market demand.
6. Numerical exploration To obtain further insights on the mobile service supply chain, we conduct numerical analyses on findings in the previous section. We assume sale period N=1,

the variable cost of per unit service of CP cs 2 =0.1 , the MNOs per unit variable cost of service c0 =0.2 and the fixed cost of CP cs1 =1.50 million . We assume customer demand obey exponential distribution and the distribution function is x 1 e , x > 0 F ( x, p ) = , = (m np ) 2 m = 300, n = 100 .The relationship between 0, x 0
network capacity qi and fixed cost cmi is shown in Table 1. Based on Proposition 2 and table 1, we calculate the supply chain coordination parameters and in Table 2. It indicates that an increase of and a decrease of respectively reduce the MNOs and the CPs risk to coordinate the supply chain. Network capacity qi million time 10 30 60 100 150 250 300 400 500 700 Fixed cost cmi million 0.20 0.40 0.60 0.75 0.90 1.10 1.30 1.40 1.60 1.80

Table 1: Network capacity and fixed cost After some algebra, we find that S (qi , p) = qi F ( x, p)dx = (300 100 p ) [1 e
2
0
qi
2

qi

qi (300 100 p ) 2

and ( qi , p ) = ( p 0.3)(300 100 p ) 2 [1 e (300 100 p ) ] 150 cmi .

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Fixed cost cmi million 0.20 0.40 0.60 0.75 0.90 1.10 1.30 1.40 1.60 1.80

(%)

()
0.1647 0.1399 0.1143 0.1000 0.0875 0.0731 0.0607 0.0552 0.0452 0.0364

11.76 20.05 28.57 33.33 37.50 42.31 46.43 48.28 51.61 54.55 Table 2: Coordination parameters and

Using Matlab7.0, we calculated the optimal sale price and the supply chains profit under given network capacity. The results are shown in Table 3. With the increase of network capacity, the optimal sale price is diminishing, which increases the supply chains profit. qi (million time 10
30 60 100 150 250 300 400 500 700

pi*
)

(qi , pi* ) (million 16.640 43.607 74.648 106.65 137.48 181.14 197.02 221.48 238.80 260.71

m (qi , pi* ) (million ) 1.956864 8.743203 21.327 35.546 51.555 76.640 91.476 106.930 123.240 142.220

s (qi , pi* ) (million ) 14.683136 34.863797 53.321 71.104 85.925 104.50 105.54 114.55 115.56 118.49

2.4141 2.1935 2.0250 1.8877 1.7727 1.6245 1.5719 1.4910 1.4312 1.3491

Table 3: The optimal sale price and supply chain profit

7. Conclusions This paper studies the mobile service supply chain composed of a mobile network operator and a single content / service providers. Mobile service supply chain in which the product is service is different from the traditional supply chain. Therefore, the model does not consider the inventory problem and we regard the network capacity as a discrete value. The main contributions of this paper are that we apply revenue sharing contract to the mobile service supply chain and prove that under certain conditions the contract can optimize and coordinate the supply chain.

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Although revenue sharing contract is a strong coordination of contracts, in the traditional product supply chain, it is difficult to implement. The supplier does not want to use this contract because it does not know the retailers actual income leads to the drastic decrease of supplier profit. However, in our model, sales revenue is collected by the mobile network operator. The mobile network operator and the content / service provider share sale revenue further. There is no extant problem of traditional supply chain in this model. Therefore, revenue sharing contract can well coordinate the mobile service supply chain.
8. Acknowledgements This work was partially supported by a grant from the National Natural Science Foundation of China (No. 70731001) and a grant from the National Social Science Foundation of China (No. 06BJY101). References Cachon, G. and M. Larviere (2002). Supply chain coordination with contracts. Working Paper,University of Pennsylvania. Cachon G. and Larviere M. (2005). Supply chain coordination with revenue sharing contracts: strength and limitations. Management Science 51(3), 30-44. Dana J. and Spier K. (2001). Revenue sharing and vertical control in the video rental industry. Journal of Industry Economics 59(3), 223-245. Demirkan H. and Cheng H.K. (2006). The risk and information sharing of application services supply chain. European Journal of Operational Research, 1-20. Houlihan, J. B. (1985). International supply chain management. International Journal of Physical Distribution and Materials Management 15(1), 22-38. Ilaria G. and Pierpaolo P. (2004). Supply chain coordination by sharing revenue contracts. International Journal of Production Economics 89(3), 131-139. Lu Yaobin, Dong Yuanyuan and Wang Bin (2007). Mobile business value chain in China: A Case study. International Journal of Electronic Business 5(5), 460-477. Mortimer J. (2000). The effects of revenue-sharing contracts on welfare in vertically-separated markets: evidence from the video rental industry. Working paper, University of California at Los Angeles, Los Angeles, CA. Pasternack, B. A. (1985). Optimal pricing and returns policies for perishable commodities. Marketing Science 4(2), 166-176. Shapiro, R. D. (1984). Get leverage from logistics. Harvard Business Review 5(3), 119-127. Tasy, A. A. (1999). The quantity flexibility contract and supplier-customer incentives. Management Science 45(10), 1339-1358. Veen J. and Venugopal V. (2005). Using revenue sharing win-win in the video rental supply chain. Journal of Operational Research Society 56(7), 757-762. Yuan, Y. (2006). Mobile commerce, Beijing:Tsinghua University Press.

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