How can Sherman encourage the retailer to lower the retail price to that level to boost demand without eating into Sherman’s own profit?
ASSIGNMENT QUESTIONS
1.
What is the best retail price and resulting monthly demand?
2.
How can Sherman encourage the retailer to lower the retail price to that level to boost
demand without eating into Sherman’s own profit?
3.
What should the wholesale price be?
4.
Is the only alternative to sell directly to customers?
Getting Started – Case Approach Hints:
The concept of double marginalization describes, in general, the idea that each member of a
supply chain tries to take its “share of the pie” by raising the price higher and higher. In the end,
the retail price is too high, and demand is too low, compared to the price point that would
maximize profits if the supply chain were one vertically integrated company. Consumers are
worse off as well because they pay higher prices and consume less.
In theory, the solution is simple: get all members of the supply chain to make decisions as
though they were part of one company. By making coordinated decisions instead of locally
optimal decisions, money is “created out of thin air.” As long as there is some way to share this
new money with all members of the supply chain, everyone should agree to participate.
Why doesn’t the simple solution always get implemented? Perhaps certain supply chain players
don’t recognize the power of joint decision making. Others may not trust their supply chain
partners. Still others may act like the typical participant in the “Prisoner’s Dilemma” from game
theory. That game provides an incentive for each prisoner to not cooperate with each other
(i.e. to rat out his partner). So even though both prisoners would be better off cooperating
(“don’t confess”), more often than not they end up only looking out for their own best interest
(“confessing”).
In this case, Shawn has figured out the best price point that will maximize profits for the
supply chain, but the retailer won’t comply because, from the retailer’s view, more profits can
be earned by charging a higher price.
Fixed costs are ignored in this case, so the monthly profit for each party simply equals the
monthly demand times the profit margin. Shawn’s profit margin equals the wholesale price
minus his variable cost of $2.00. The retailer’s profit margin equals the retail price minus the
wholesale price that Shawn charges. In game theory terminology, this is a Stackelberg game
where the supplier (Sherman’s Soda) moves first by setting the wholesale price, and then the
retailer reacts accordingly.
The data in Table 1 suggest a purely linear demand function (note there is additional data
within the text). Use all data to determine the slope and intercept and come up with the linear
equation for market demand [Q(p) = a – bp] for the case. You can do this by hand or by using
Microsoft Excel’s SLOPE (to solve for b) and INTERCEPT (to solve for a) formulas. (Q is quantity/
demand and p is the retail price.
