Supply chain coordination by contracts considering dynamic reference quality effect under the O2O environment

Highlights

• Study O2O supply chain coordination with dynamic reference quality effect.

• Use wholesale price, cost-sharing and two-part tariff contracts for coordination.

• Transform the developed dynamic models with the three contracts to tractable forms.

• Compare equilibrium solutions among the three contracts.

• Perform numerical studies to verify the results and to provide managerial insights.

Abstract

This study investigates the coordination problem for a two-tier decentralized supply chain consisting of a supplier and a retailer. The supplier can control and adjust the product quality and the retailer sells the product both offline and online (O2O) to consumers with reference quality effect. The market demand is dependent on the retail price and on the consumer reference quality effect that is a dynamic function of past product quality. The problem is modeled as a Stackelberg game with the supplier as the leader and the retailer as the follower. The wholesale price (WP), cost-sharing (CS) and two-part tariff (TP) contracts are used to coordinate the decentralized supply chain. Using the Hamilton-Jacobi-Bellman equation, the dynamic optimal control models are transformed into tractable models to obtain the equilibrium solutions. The results show that the decisions of the supply chain members are dynamic and depend on the consumer initial reference quality, the reference quality effect strength and the memory parameter. The retailer should attract potential consumers with dynamic reference quality effect to purchase the product offline. The TP contract can coordinate the supply chain and can benefit the supplier, the retailer and the consumers. As compared with the WP contract, the CS contract can improve the performance of the supply chain. These results are verified through numerical experiments. The impacts of the major parameters, including the reference quality effect strength, the consumer memory parameter, the cost-sharing rate, the discount rate and the offline consumer rate, on the equilibrium solutions and on the profits of the supply chain members are also examined through numerical experiments.

Introduction

With the improvement of living standards, consumers increase the weight on and have an expectation for high product quality. This expectation is mainly derived from the experience with the quality of products used before. However, this expectation for quality significantly affects the consumer purchasing behavior and the business brand recognition. Thus, business firms, especially online stores, take advantage of the influences of this expectation to make precise decisions that return more benefits. Some e-tailers bear the return shipping costs to make up for the losses of the consumers who are unsatisfied with the product quality. Some e-commerce businesses set up showrooms for consumers to experience the quality of their products. While consumers can purchase the product online if they are satisfied with the quality, more e-commerce businesses, such as JD, MI and Three Squirrels, choose the online to offline (O2O) sales mode to let consumers fully understand the quality of their products. The O2O sales mode is a business model that attracts potential customers from online channels to purchase the products or services in both online and offline channels. By incorporating techniques used in online and offline marketing, O2O identifies customers mainly in the online space, such as through social media, emails and Internet advertising, and then uses a variety of techniques and approaches to persuade the customers to purchase the product or service. With O2O, consumers can experience the quality of the products offline and pay for the products either offline or online. If the consumers satisfy with the quality of a product in offline stores and purchase the product, then this pleasant shopping experience may make them purchase the same product in online stores in the future.

Thus, some researchers have extended the reference point in prospect theory to product quality. A theoretical framework for value functions about consumer choices has been developed, and the theoretical framework shows that product attribute is evaluated in relation to a reference point (Tversky & Kahneman, 1991). An attribute of a product, e.g., the retail price, is compared to the same reference level. This reference-dependent evaluation of an attribute applies not only to the retail price but also to the product quality, i.e., a reference quality (Hardie, Johnson, & Fader, 1993). Reference quality is the consumer expectation about product quality based on the historical experience, and can be explained as the consumer perception of the product quality that is formed over time from information of historical product quality, price and so on (Kopalle & Winer, 1996). This perception is dynamic and significantly affects consumer purchasing behavior (Gavious & Lowengart, 2012). Thus, both real-world practices and theoretical analyses indicate the need in studying the impacts of consumer reference quality on decisions made by business firms with the O2O sales mode, especially under the highly competitive market today.

Most studies on consumers with reference quality effect simply focused on single subjects and aimed to obtain pricing and quality decisions. However, to place the product in an invincible position in the market competition, a coordination contract in the supply chain is also a crucial issue that should not be ignored. On the one hand, a coordination contract can improve the sustainable performance of the supply chain. On the other hand, the members of the supply chain need to cooperate and jointly face the impacts of the reference quality behavior on the supply chain to make the decisions to satisfy both the supply chain members and the consumers. Therefore, considering supply chain coordination contracts is realistic and relevant in business research and practice.

Consumer reference quality effect is universal and changes over time in practice. A supply chain with dynamic reference quality effect makes very different decisions from those of a supply chain without dynamic reference quality effect. Thus, a supply chain under the O2O environment should introduce dynamic reference quality effect to develop a more practical decision framework when setting up a coordination contract to optimize the supply chain performance. However, limited attention has been paid to the supply chain coordination contracts considering dynamic reference quality effect under the O2O environment. Most works only investigated a single subject or a decentralized supply chain although they considered the reference quality effect. Three different, i.e., a wholesale price (WP), a cost sharing (CS) and a two-part tariff (TP), contracts are introduced to coordinate the supply chain in this work, so as to fill the research gap by answering the following research questions. (1) How to solve the supply chain coordination problem with dynamic reference quality effect under the O2O environment to make the retail price, product quality and wholesale price decisions? (2) What are the impacts of the important problem parameters on the decisions and profits of the supply chain members? (3) Can the WP, CS and TP contracts coordinate the supply chain, and which contract can benefit the supplier, the retailer and the consumers?

To address the above questions, this work considers a two-tier supply chain consisting of a supplier and a retailer. The supplier produces the product to sell to the retailer and has the ability to control and adjust the product quality. The retailer faces consumers with the reference quality effect and sells the product to them through offline stores, online stores or a combination of them, i.e., O2O. The demand is assumed to be dependent on the retail price and on the reference quality that is a dynamic function of the past product quality. A Stackelberg game model is developed with the supplier as the leader and the retailer as the follower. A centralized system, i.e., centralized supply chain, and a decentralized system, i.e., decentralized supply chain, are analyzed and their equilibrium results are compared. The WP, CS and TP contracts are used in the decentralized system to coordinate the supply chain. Using the Hamilton-Jacobi-Bellman (HJB) equation, the dynamic optimization models in an optimal control approach are solved to obtain the equilibrium solutions. The impacts of some important parameters on the equilibrium solutions and profits of both the supplier and the retailer are analyzed. To evaluate the effectiveness of the coordination contracts, the equilibrium solutions of the centralized and decentralized systems are compared. Furthermore, numerical studies are performed to verify the theoretical results and to provide valuable managerial implications to the supply chain members.

This study contributes to the theoretical modeling of behavioral operational management in the following ways. First, dynamic reference quality effect is incorporated into supply chain coordination under the O2O environment for the first time, and the expressions of the optimal retail price, product quality and wholesale price are provided. Liu, Sethi, and Zhang (2016) studied supply chain coordination with dynamic reference quality effect, but did not consider the O2O sales mode and only used one contract for coordination. Second, the WP, CS and TP contracts are used to coordinate the supply chain with reference quality effect under an O2O environment for the first time. He, Xu, Xu, and Wu (2016) also used the CS contract to coordinate the supply chain with dynamic reference quality effect, but did not consider the O2O sales mode and only focused on the product quality decision. Third, the theoretical results of comparative analyses are provided for the equilibrium solutions under the three contracts, and are verified through numerical experiments.

The rest of this paper is structured as follows. Section 2 provides a brief review of the relevant literature and highlights the contributions of this study. Section 3 describes the problem and formulates the Stackelberg game model with reference quality effect under the O2O environment. Section 4 proposes a centralized system as the benchmark of supply chain coordination. Section 5 investigates the three different contracts to coordinate the supply chain with reference quality effect and compares their performance to the benchmark. In Section 6, numerical studies with sensitivity analyses of the key parameters are performed. Applications of obtained results and managerial implications to supply chain members are presented in Section 7. Conclusions and future research directions are given in Section 8. All proofs of the propositions are provided in the Appendix.