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.