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2011 MSOM Annual Conference

Ann Arbor, Michigan, June 26-28, 2011

Revenue Sharing and Information

Leakage in a Supply Chain
Guangwen Kong

University of Souhern California

Sampath Rajagopalan

University of Southern California

Hao Zhang

University of Southern California

Revenue Sharing and Information Leakage in a Supply Chain

Guangwen Kong, Sampath Rajagopalan, Hao Zhang
Department of Information and Operations Management, Marshall School of Business
University of Southern California, Los Angeles, CA 90089

Advances in information technology have had a dramatic impact on the ability of rms in a supply chain to share information. This has been heralded as a key part of the information revolution
and numerous rms have taken advantage of these advances. Greater collaboration between rms
in a supply chain has resulted in initiatives such as Collaborative Planning, Forecasting and Replenishment (CPFR) and well-known manufacturers such as Proctor and Gamble and Black Decker
as well as major retailers such as Home Depot and Wal-Mart have participated in these eorts.
While information sharing has resulted in many benets, there have been many challenges too.
One of the major challenges has been the reluctance of some rms to share information vertically
with suppliers due to the fear of leakage of this information to their competitors. In this case, the
many benets of information sharing are not realized and all the parties in the supply chain may
be worse o.
The issue of information sharing and leakage is clearly most salient when the information is
valuable and demand information is often particularly valuable in a supply chain. One retailer may
have a considerable advantage over others in access to or in acquiring demand information and
this can be a source of signicant competitive advantage. The retailer can exploit this information
advantage for instance by producing and selling more if demand is likely to be higher and thus
achieving higher revenues. A toy retailer may be popular with young mothers and may be able to
identify market trends earlier than say discount or mass market retailers selling toys. The same
may be true for a retailer selling exclusively video games or other similar products. A retailer
may be able to exploit this informational advantage only with the cooperation of the supplier who
manufactures the product. But the advantage may dissipate if the common supplier leaks the
demand information or an equivalent signal to a competitor. While we have framed our discussion
in terms of retailers sharing information with a supplier, the same issues are salient in the context
of a manufacturer sharing information with the supplier of, say, a critical part.

Our goal in this work is to identify contracts that enable information sharing in a supply chain
without the negative eects of information leakage. In particular, we consider a stylized supply
chain with one supplier selling to two retailers who compete for customers. One of these retailers
(the incumbent) is privy to private information about market potential and places an order based
on this information. The supplier may leak this information to the second retailer (the entrant) if
it benets her and in turn this would impact the order quantity placed by the rst retailer. The
two retailers engage in Cournot competition, i.e. they sell in a market where the price is inversely
proportional to their cumulative order quantities. Anand and Goyal (2009) analyzed an identical
scenario and showed that the supplier will always leak information under a wholesale price contract.
The information leakage may result in a less e cient supply chain with lower prots potentially for
all parties. If the supplier can make a credible commitment not to leak, the supplier might benet
from it. So, we consider what would happen if the supplier uses a revenue sharing contract wherein
she sells the product to the two retailers at a (possibly lower) wholesale price but also receives
a share of the retail revenue. Revenue sharing contracts are common in several industries and
have been shown to be eective in coordinating supply chains (Dana and Spier 2001, Cachon and
Lariviere 2005). Our objective is to explore if and when a revenue sharing contract might reduce
the suppliers incentive to leak information and the impact of such a contract on the decisions and
prots of the supplier and retailers in the supply chain. While revenue sharing contracts have been
analyzed in the literature from a supply chain coordination perspective, their role in addressing
information leakage issues have not been analyzed.

In order to nd a leakage-proof revenue sharing contract, we begin with two benchemark scenarios: the rst is that the suppplier can make a credible commitment not to leak the incumbents
order quantity to the entrant, and the second is that the supplier always leaks the incumbents
order quantity to the entrant. A simultaneous game is played by the two retailers if the supplier
can commit not to leak information, while a signaling game is played if the supplier always leaks.
In the latter situation, the incumbent would take into account the entrants updated belief of the
demand state and corresponding action after learning the incumbents order. The results in these
two benckmark scenarios lead us to establish the suppliers incentive comatitibility with nonleakage and then the incubments. To be specic, we nd a range of the incumbents order quantity in
which the supplier prefer nonleakage and the incumbents order quantity in equilibrium fall into the
suppliers nonleakage range under both high and low demand states. Furthermore, we characterize

the set of contract parameters (wholesale price and revenue sharing rate) under which nonleakage
can be sustained.
Our analysis reveals that a revenue sharing contract leads to many interesting eects on the
actions and prots of the supplier and retailers. First, from the suppliers point of view, if the
demand information is fully shared across the supply chain, the retailers tend to over-order when
the demand is high and under-order when the demand is low. Thus, there is value for concealing that
information and letting the uninformed retailer place a moderate order, which mitigates the quantity
distortion in the supply chain. In that sense, revenue sharing help the supply chain outperform
simple Cournot with perfect information. Second, if the retailer with private demand information
does not want the supplier to leak this information, his order quantity needs to be distinguishable
(falling outside of an intermediate interval) to demonstrate the quantity distortion to the supplier.
That is, contrary to the common wisdom, the informed retailer should not hide information from
the supplier to prevent leakage. Third, we show that there exist many combinations of wholesale
price and revenue share percentage under which the supplier will not leak information. Preventing
information leakage may result in higher prots for both the incumbent and supplier relative to a
scenario where the supplier leaks information and, interestingly, even the entrant may be better o
sometimes. Fourth, our results also suggest that a revenue share percentage that is neither too low
nor too high is more capable of preventing leakage. This middle range is consistent with studios
revenue share percentages (40-60%) in the video rental industry as well as their share of revenues
with movie theaters (Dana and Spier 2001). In this scenario, the supplier may even be able to choose
a wholesale price that maximizes her prots while preferring not to leak information. Thus, we
have established that a revenue sharing contract can be robust in its ability to prevent information
leakage. Fifth, as the range of potential demand values (high versus low) increases, nonleakage
becomes more likely, i.e. the possible set of wholesale prices and revenue share combinations for
which nonleakage is an equilibrium expands. In such a scenario, the potential quantity distortion
is more severe and hence the supplier leans toward nonleakage more willingly.

Anand, K. S. and M. Goyal. 2009. Strategic information management under leakage in a supply
chain. Management Science 55(3) 438452.
Cachon, G., M. Lariviere. 2005. Supply shain coordination with revenue-sharing contracts:

strengths and limitations. Management Science 51(1) 3044.
Dana, J. D., Jr., K. E. Spier. 2001. Revenue sharing and vertical control in the video rental
industry. Journal of Industrial Economics Vol. XLIX, 3 224245.