How a retailer should manipulate a dominant manufacturer's perception of market and cost parameters

Abstract

A manufacturer supplies a retailer who has private superior knowledge about three system parameters; namely, market size, market sensitivity, and her retail-processing cost. For each parameter, the manufacturer's imperfect knowledge is characterized by a subjective distribution. Should the retailer help to improve the manufacturer's imperfect knowledge when the manufacturer is designing his supply contract? Can the manufacturer induce the retailer to share her superior knowledge by informing the retailer that he will be using sophisticated channel-coordinating contract formats? It is likely that one would surmise from the literature that the answer to both questions is "yes." However, this paper shows that very often the correct answer is "no." Specifically, for each of the three system parameters, we show that the retailer is: (i) always motivated to mislead the manufacturer to have a biased mean value for his subjective distribution; and (ii) motivated, over a wide range of likely conditions, to increase the variance of the manufacturer's subjective distribution. Moreover, the manufacturer cannot narrow this range of confusion-encouraging conditions by using a more sophisticated contract among the current known formats (including a "menu of contracts"). Our results highlight the need to develop arrangements that can actually motivate a dominated retailer to share knowledge honestly. © 2008 Elsevier B.V. All rights reserved.