Supply chain coordination through cooperative advertising with reference price effect
Highlights
► We incorporate the reference price effect into the co-op advertising in a vertical supply chain. ► We propose a dynamic co-op advertising model to analyze the impact of reference price effect. ► We analyze the impact of the reference price effect on the supply chain advertising decisions. ► We propose a new coordinate policy for the supply chain coordination in co-op advertising.
Introduction
Cooperative advertising, which usually occurred in a vertical supply chain, is typically a cost sharing and promotional mechanism for manufacturers to affect retailer performance. As distinguished by Huang and Li [18] and Huang et al. [19], advertising can be divided into national and local advertising. National advertising mainly focuses on influencing potential consumers to consider a particular brand and develops brand knowledge and preference, whereas local advertising intends to stimulate consumers' instant buying behavior. To encourage a retailer to invest more in local advertising, the manufacturer usually shares part of the retailer's local advertising cost.
As a typical issue of supply chain coordination, the cooperative advertising program has received significant attention in business and academics. As indicated by Nagler [35], the total expenditure on cooperative advertising in 2000 was estimated at $15 billion in the USA, nearly a four-fold increase in real terms in comparison to $900 million in 1970. Karray and Zaccour [27] also indicated that marketing research firms like National Register Publishing has collected more than 4000 co-op programs subsidized by manufacturers in 52 product classifications.
In 1973, Berger was the first to propose a primary cooperative advertising model [5]. After that, Dant and Berger [9], Huang and Li [18], Huang et al. [19], Li et al. [32], Jørgensen et al. [20], [21], Yue et al. [51] and Xie and Neyret [49] extended different aspects of Berger's work. There are two types of modeling in co-op advertising: static and dynamic. For example, Huang and Li [18], Huang et al. [19] and Li et al. [32] used static models to extended Berger's work in a supply chain framework; Yue et al. [51] used a static model to study the cooperative advertising problem by considering price discount in demand elasticity market circumstance, and Xie and Neyret [49] used a static model to propose a more general model by including the cooperative advertising and pricing decisions simultaneously.
For the dynamic models, readers may refer to Chintagunta and Jain [7], Jørgensen et al. [20], [21], and Karray and Zaccour [26]. Utilizing the Nerlove–Arrow framework, Chintagunta and Jain [7] developed a dynamic model to determine the channel member's equilibrium marketing efforts for a manufacturer–retailer supply chain. Jørgensen et al. [20] extended the work of Chintagunta and Jain [7] for cooperative advertising by considering that both channel members made long term and short term advertising efforts to enhance sales and consumer goodwill, whereas Jørgensen et al. [21] assumed decreasing marginal returns to goodwill and adopted a more flexible functional form for the sales dynamics. These works were extended by Karray and Zaccour [26], in which the retailer sold both his own private product and the manufacturer's product. Further, under the dynamic framework, He et al. [15] studied the cooperative advertising program for a supply chain system consisting of a single manufacturer and two competing retailers.
Although cooperative advertising has been extensively studied during the past several decades, an important marketing phenomenon, i.e., reference price effect, has not been considered in the cooperative advertising models. In fact, reference dependence has a long-standing tradition in psychology and has been the focus of a great deal of empirical research [4], [6], [30]. According to Kalwani et al. [23], when a consumer buys a product, he usually has a reference price r in his mind. If he finds the current price p is less than his reference price r, he will feel a sense of gain and the sales of the product would increase. On the contrary, if r<p, the consumer will feel a sense of loss and sales would decrease. In the literature, the impact of reference price on demand is called reference price effect [37]. As argued by Mazumdar et al. [34], reference price represents a consumer's evaluation of a product; the reference price is affected by many factors such as price (including the historical price, the suggested retail price, the rival product's price, etc.), advertisement, quantity, delays, and so on.
Due to its significant influence on consumers' behaviors, reference price has received much attention from researchers. Thaler [47] explained that the impact of a reference price on consumer demand was influenced by the dynamic comparison between reference price and current market price. Pulter [38] further indicated that an actual price which is higher or lower than the reference price has a different impact on demand. Greenleaf [12] showed that reference price effect could increase the impact of promotions. Taking this effect into account, Greenleaf demonstrated how a retailer should develop an optimal strategy for long-term promotions to maximize his profits. Kopalle et al. [29] considered customer heterogeneity in a study of reference price effect and showed that cyclical pricing policies were optimal. Taking threshold effects into account, Raman and Bass [40] provided a test of reference price theory and assumed a basic asymmetry in market response. Their research suggested that a price-promotion would not be noticed by consumers except if it exceeded a minimum threshold. Fibich et al. [14] studied how the profitability of price promotion was affected by the asymmetric reference price effect and results showed that if effects of loss on demand were larger than that of gain, price promotions could lead to a decline in profit, and vice versa.
Because reference price has a significant impact on consumer buying decisions and because reference price can be affected by advertising, it is necessary to consider the reference price effect in cooperative advertising models so that managers can make better decisions about promotional strategies. In this paper, we consider a dynamic cooperative advertising model with reference price effect for a manufacturer–retailer supply chain. In our model, both the consumer's goodwill and reference price for a product are assumed to be influenced by advertising and are modeled in differential dynamic equations. In addition, the advertising efforts, the consumer's goodwill, and the reference price are all assumed to have a positive effect on product sales. Utilizing differential game theory, we obtain the optimal advertising decisions of the manufacturer and retailer under two different game scenarios, i.e., the Stackelberg game and the cooperative game structure. Also, we propose a new cooperation mechanism to coordinate the supply chain in which both the manufacturer and retailer share the other's advertising costs.
Some interesting results of this paper include the following: (i) as opposed to most previous literature, which did not take into account advertising's impact on reference price and proved that the steady state reference price equals to the market price [13], [37], our model illustrates that the steady state reference price is usually higher than the market price; (ii) due to the reference price effect, a firm will invest more in national advertising; the larger the impact of the reference price, the more national advertising should be invested in, and (iii) when the retailer has a relatively high profit, it is necessary for him to share a part of the manufacturer's national advertising costs, which is contrary to the common cooperative advertising practice by which the manufacturer usually shares the retailer's local advertising costs.
This paper is organized as follows. Literature reviews are in Section 2. In Section 3, the reference price effect is added into the dynamic cooperative advertising model. Based on the model, in 4 Stackelberg game (non-integrated decision), 5 Coordination we analyze the manufacturer and retailer's optimal decisions in the Stackelberg game and the cooperative game structure, respectively. A new supply chain coordination mechanism is introduced in Section 6. Concluding remarks are given in Section 7.
Section snippets
Literature review
Literature related to this paper focuses mainly on cooperative advertising and reference price effect. Research about cooperative advertising is usually divided into static models and dynamic models. For the static model, Berger [5] proposed a cooperative advertising model by taking the participation rate as the manufacturer's decision variable, i.e., the manufacturer was to decide the optimal cost sharing rate that he would undertake for the retailer. The model was then extended by Dant and
Model development
The system considered in this paper consists of a manufacturer and a retailer. The manufacturer sells his product to the retailer while the retailer sells the product to the consumer. To improve sales, the manufacturer will usually invest in national advertising and the retailer in local advertising. We denote the manufacturer's national advertising level over time t as a(t), and the retailer's local advertising level as q(t).
Generally, when the two channel members advertise a product, a kind
Stackelberg game (non-integrated decision)
When the two firms make decisions independently, the decision structure is assumed as follows. The manufacturer firstly offers the retailer a participation rate ϕ1 that he is willing to assume for the local advertising costs. Once the participation rate is given, both the manufacturer and the retailer will decide their advertising efforts over time. Since such advertising decisions may change all the time, it is reasonable to assume that the two firms make their advertising efforts decisions
Coordination
In this section, we assume that the manufacturer and the retailer are vertically integrated and we calculate the system optimal decisions that maximize the present value of the whole supply chain profit. When the two firms coordinate as an integrated system, the system objective is given by Eq. (11). Taking the respective state Eqs. (1), (2) into account, the present value Hamiltonian for the total channel is given as follows:
A two-way subsidy policy
In Section 5, we reached the following conclusion: when the manufacturer and retailer coordinate as an integrated system, the optimal national and local advertising efforts are larger than in the Stackelberg game structure. Since the supply chain profits are usually higher in the cooperative game structure, it is necessary to design a contract so that the two channel members will choose the system optimal decision even when they make their decisions independently. To achieve this purpose, we
Concluding remarks
As an important consideration when consumers decide whether to buy a product or not, reference price has a significant impact on consumer behavior. Considering that national and local advertising can also influence the consumer's reference price, this paper investigates the cooperative advertising problem by taking reference price effect into account. Utilizing the differential game theory, the manufacturer and retailer's optimal efforts on national and local advertising are calculated in a
Acknowledgments
This work was supported by the National Natural Science Foundation of China (Grant no. 70901068), the Funds for International Cooperation and Exchange of the National Natural Science Foundation of China (Grant no. 71110107024), Anhui Provincial Natural Science Foundation (Grant no. 090416240) and Chinese Universities Scientific Fund. Liang Liang and Qinglong Gou would also like to acknowledge the Science Fund for Creative Research Groups of the National Natural Science Foundation of China
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