Customer-driven vs retailer-driven search: Channel performance and implications

A common phenomenon that occurs in any decentralized multilocation system is stock imbalance, whereby some locations have unsatisfied demands while others are overstocked. The system can be rebalanced by using a search process that is driven by either the customers or the retailers. In a customer-driven search (CDS), the customer with unmet demand may search for the product at another location and, if it is available, complete the purchase. In a retailer-driven search (RDS), the retailer with unsatisfied demand searches for product and schedules transshipment to fulfill the unmet demand at his location. Of course, the revenues generated through search in RDS need to be shared between the parties according to a transfer pricing scheme. In a setting of one manufacturer and two retailers with price-dependent and random demand, we explore the impact of the search method and the transfer price scheme used on the preferences of the manufacturer, the retailers, and the customers. With endogenous retail prices, we find that both the manufacturer and the retailers prefer RDS over CDS when they can design the transfer pricing scheme in RDS. Interestingly, neither party prefers the fixed transfer pricing scheme commonly assumed in the literature. Instead, transfer price that is proportional to the price of the retailer with either excess stock or excess demand is preferred. However, although both parties favor an RDS system when they can design the transfer pricing scheme in RDS, they may prefer RDS or CDS when the other party designs the RDS. Thus, the interests of the manufacturer and the retailers are rarely aligned. Customers benefit from a lower price in an RDS but at the expense of lower availability (as measured by the level of safety stock).