European Journal of Operational Research 147 (2003) 530–548

www.elsevier.com/locate/dsw

Production, Manufacturing and Logistics

Effects of a demand-curveÕs shape on the optimal solutions

of a multi-echelon inventory/pricing model
Amy Hing Ling Lau a, Hon-Shiang Lau b,*

a
Department of Accountancy, Hong Kong Polytechnic University, Hong Hum, Kowloon, Hong Kong
b
Department of Management Sciences, City University of Hong Kong, Tat Chee Avenue, Kowloon, Hong Kong
Received 3 May 2001; accepted 8 March 2002

Abstract

When a price–demand relationship is needed in inventory/pricing models, very often a convenient (typically linear)
function is arbitrarily chosen. The common-wisdom implication is that any downward-sloping demand curve would
lead to similar conclusions. This paper applies different demand-curve functions to a simple inventory/pricing model,
and shows that while the common-wisdom implication is valid for a single-echelon system, assuming different demand-
curve functions can lead to very different results in a multi-echelon system. In some situations, a very small change in
the demand-curve appearance leads to very large changes in the modelÕs optimal solutions. Other significant but
counter-intuitive effects of the demand-curve form are also revealed. This paper does not completely resolve the dif-
ficulties revealed by the counter-intuitive effects reported here, but establishing the existence of these effects represents a
first step towards developing procedures to handle such effects; these procedures will be necessary to ensure the reli-
ability of many multi-echelon models for products having price-sensitive demands.
Ó 2002 Elsevier Science B.V. All rights reserved.

Keywords: Supply chain management; Pricing; Retailing; Inventory

1. Introduction ing, a productÕs demand curve has to be specified

1.1. Motivation
Few economics/business concepts are as well-
known as a ‘‘downward sloping’’ price–demand
curve (hereafter ‘‘demand curve’’); i.e., demand
decreases as price increases. In inventory model-
*
Corresponding author.
E-mail addresses: acahllau@inet.polyu.edu.hk (A.H.L. Lau),
mshslau@cityu.edu.hk (H.-S. Lau).
if, besides such standard ‘‘inventory’’ decision
variables as order quantity and order timing,
the decision-maker must also decide on the selling
price. The increasing attention to supply chains
leads to more studies on multiple-echelon systems,
which in turn leads to an increasing need to specify
a demand curve because one encounters more
often the last echelon of the supply chain i.e., the
retailer–consumer interface.
The two most commonly-used mathematical
functions for representing a downward-sloping
price (p) versus demand (d) relationship are the

0377-2217/03/$ - see front matter Ó 2002 Elsevier Science B.V. All rights reserved.
doi:10.1016/S0377-2217(02)00291-6
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548
linear ðd ¼ a  bpÞ and the iso-elastic ðd ¼ Kpa Þ.
Since both of these functions are introduced in
numerous standard economics textbooks, typically
one of the two is selected (seemingly arbitrarily) as
a matter of course when a demand curve is needed
in an inventory/pricing model. There is seldom any
justification on why one function is picked instead
of the other, or on whether either of the two is
appropriate at all as a demand curve––see, e.g.,
how the linear demand curve was picked in,
among many others, Lau and Lau (1988), Parlar
and Wang (1994), Chu and Messinger (1997),
Emmons and Gilbert (1998), Petruzzi and Dada
(1999) and Khouja (2000); or how the iso-elastic
curve was picked in, among many others, Weng
(1995), Li et al. (1996), Urban and Baker (1997)
and Petruzzi and Dada (1999). The implication,
presumably, is that any ‘‘reasonable’’ downward
sloping function would lead to similar conclusions.
On a different perspective, in the literature there
are also numerous empirical estimations of de-
mand curves for a wide variety of products. Again,
a mathematical function is first assumed for the
demand curve; then the functionÕs parameters are
estimated from empirical data using (say) regres-
sion. In many of these empirical estimations p is
often only one of several explanatory variables for
d; for our purpose it suffices to note that in em-
pirical demand-curve estimations the assumed
function is seldom linear in p; more often it is iso-
elastic in p (as in e.g., Banaszak et al., 1999; Ward,
1999). Sometimes, d is also an exponential func-
tion of p; i.e., d ¼ c expðbpÞ (as in e.g., Stavins,
1997). Empirical elasticities quoted by these stud-
ies (see also e.g., Crouch, 1994; Weingarten and
Stuck, 2001) range from roughly 0.15 to 10; some
of these quoted elasticities appear to correspond
to the a-value in the Kpa -term of an underlying
iso-elastic curve.
This paper considers five price–demand func-
tions, and shows that when applied to a multi-
ple-echelon inventory system, even very small
differences in the demand functions can lead to
very different results. Some important but over-
looked properties of standard demand curves are
also presented. Among other things, our results im-
ply that: (i) an analyst cannot always blissfully
assume that multi-echelon results obtained by as-
531
suming one downward-sloping demand curve are
easily transferable to other forms of downward-
sloping demand curves; (ii) more empirical ground-
work needs to be done on estimating the true form of
the demand curve before definitive answers are ob-
tainable for some multi-echelon inventory systems.
Our study began as an attempt to extend the
published results on incorporating a demand curve
into one-echelon and two-echelon newsboy-type
(hence stochastic demand) inventory systems (as
in e.g., Emmons and Gilbert, 1998; Petruzzi and
Dada, 1999). However, we found that using dif-
ferent standard demand curves in these stochastic-
demand systems led to incoherent results. This led
us to realize that, before these demand curves can
be safely applied to stochastic models, we need to
improve our understanding on the more basic
issue of how simple deterministic multiple-echelon
systems are affected by different forms of demand-
curves. Therefore, this paper considers only de-
terministic demand curves.
1.2. Definitions
This paper will consider one-echelon, two-ech-
elon and three-echelon systems. Our one-echelon
system consists of an integrated firm doing both
manufacturing and retailing. In the two-echelon
system the manufacturer and the retailer are two
separate entities; we assume a Stackelberg process
in which the manufacturer sets the wholesale unit
price w, then the retailer responds by setting order
quantity Q and unit retail price p (this Stackelberg-
process is a standard inter-echelon interaction
mechanism assumed in numerous inventory mod-
els; see, among many others, Parlar and Wang
(1994), Li et al. (1996), Emmons and Gilbert
(1998)). In the three-echelon system the manufac-
turer sells to the wholesaler at unit price W, the
wholesaler responds by selling to the retailer at w,
then the retailer responds by setting Q and p.
The demand curves considered in this study are:
(a) the linear demand curve d ¼ a  bp, where a
and b are positive constants, p 6 a=b;
(b) the iso-elastic curve d ¼ Kpa , where K and
a are positive constants (this curve has a
532 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548
constant demand elasticity of a, or a, de-
pending on the convention used);
(c) the exponential curve d ¼ c expðbpÞ, where c
and b are positive constants; and
(d) the ‘‘algebraic’’ curve d ¼ ðkp þ bÞa , where k,
b and a are constants, k P 0, a P 0.
Curves (a) and (b) are by far the most commonly
assumed forms in inventory modeling. Among
others, Jeuland and Shugan (1988) considered
forms (c) and (d) in analytical modeling, and form
(c) is also commonly assumed in the empirical es-
timation of demand curves. Later in this paper we
will also consider ‘‘hybrid’’ demand curves formed
by mixing the linear and the iso-elastic curves.
Define:
h is the deterministic profit. hÕs first subscript is
in lower case and denotes the demand-curve form;
it will be either l for linear, c for constant-elasticity
(iso-elastic), e for exponential, a for algebraic, or h
for hybrid. hÕs second subscript is in upper case,
it will be either M (for manufacturer), W (for
wholesaler), R (for retailer), C (for channel, i.e.,
‘‘manufacturer plus retailer’’ or ‘‘manufacturer plus
wholesaler plus retailer’’), or I (for the integrated
firm doing both manufacturing and retailing). For
example, hlR is the retailerÕs profit under a linear
price–demand function. However, hR denotes the
retailerÕs profit when a demand-curve identifier is
not needed; note that here the single upper-case
subscript R could not be confused with the
(supposedly preceding) lower-case demand-curve
identifying subscript. The same subscripting con-
vention will be used for other relevant symbols
such as p, Q, etc.;
m is the unit manufacturing cost;
W is the unit wholesale price charged to the
wholesaler by the manufacturer (only in a three-
echelon system);
w is the unit wholesale price charged to the re-
tailer either by the manufacturer (in a two-echelon
system) or by the wholesaler (in a three-echelon
system);
p is the unit retail price the retailer charges the
consumers;
d is the deterministic demand;
Q is the quantity ordered by the retailer and
supplied to the retail market.
1.3. Overview
First, for the four standard demand-curve
functions, we present in Sections 2–4 results on,
respectively, a one-echelon, a two-echelon and a
three-echelon inventory/pricing system. Some of
our results look peculiar. Section 5 points out an
overlooked basic property of the linear demand
curve which partially explains some of the results
in the preceding sections. Section 6 attempts to
further reconcile the results presented in Sections
2–4; while this attempt leads to some reconcilia-
tion, it also reveals more unresolved problems in
modeling multi-echelon systems involving demand
curves. Section 7 illustrates how the knowledge
gained in the preceding analyses can be used to
evaluate the robustness of a multi-echelon inven-
tory/pricing model across different demand-curve
forms.
2. Brief summary of the single-echelon situation
This section summarizes results that are either
easily derivable or scattered in various stan-
dard economics textbooks and classical works.
These results pertain to an integrated firm (i.e., it
does both manufacturing and retailing), hence w
and W do not exist. Since demand is deterministic,
Q ¼ d.
2.1. Linear demand curve
When d ¼ Q ¼ a  bp, the integrated-firmÕs
profit is hlI ¼ Qðp  mÞ. Verifying that d2 hlI =
dp2 < 0 and solving ‘‘dhlI =dp ¼ 0’’ gives
plI ¼ ½m þ ða=bÞ=2; ð1aÞ
QlI ¼ ða  bmÞ=2; ð1bÞ
and
hlI ¼ ða  bmÞ2 =ð4bÞ: ð1cÞ
Thus, as long as m < ða=bÞ, unique and meaning-
ful solutions exist for plI , QlI and hlI . If m P ða=bÞ,
the retailer cannot make a profit and will abandon
the business. Eqs. (1a)–(1c) are summarized in
Table 1.
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548 533

Table 1
Summary of one-echelon formulas
Linear Exponential Iso-elastic ða > 1Þ Algebraic ða > 1Þ
d ¼ a  bp d ¼ c expðbpÞ d ¼ Kpa d ¼ ðkp þ bÞa
   
m þ ab bm þ 1 am am þ bk
p
2 b a1 a1
 a  a
a  bm a1 K a1 1
Q ceðbmþ1Þ
2 a ma a ðkm þ bÞa
" # " #
ða  bmÞ2 c ðbmþ1Þ ða  1Þa1 K ða  1Þa1 1
h e
4b b aa ma1 aa kðkm þ bÞa1

2.2. The iso-elastic, exponential and algebraic 3. The two-echelon situation

demand curves
Extending the analyses in Section 2, we now
When d ¼ Q ¼ Kpa , the integrated-firmÕs profit consider a two-echelon system defined in Section 1,
is hcI ¼ Qðp  mÞ; this gives where the manufacturer sets the wholesale price w,

 then the retailer responds with order quantity Q
dhcI K am
¼ a ð1  aÞ þ : ð2Þ and retail price p.
dp p p
Solving dhcI =dp ¼ 0 gives the expressions for pcI , 3.1. Derivation of basic results
QcI and hcI as tabulated in Table 1 (it can be easily
verified that d2 hcI =dp2 < 0 when p ¼ pcI ). Observ- Consider first the linear demand curve d ¼ Q ¼
ing these expressions reveals that as long as a > 1, a  bp. The manufacturer knows that (by replac-
unique and meaningful solutions exist for pcI , QcI ing m with w in (1b)), for any w-value he sets, the
and hcI . However, if 1 P a, Eq. (2) shows that retailer will purchase Ql ¼ ða  bwÞ=2. Hence the
dhcI =dp will always be positive, hence the retailer manufacturerÕs profit will be
can realize an infinite hcI by setting an infinite pcI
hlM ¼ Ql ðw  mÞ ¼ ða  bwÞðw  mÞ=2: ð3Þ
(this phenomenon has been pointed in the past by,
e.g., Arcelus and Srinivasan (1987)). Therefore, we Solving ‘‘dhlM =dw ¼ 0’’ gives the optimal whole-
will assume a > 1 from now on. sale price set by the manufacturer as
Using the same procedure shown above, one wl ¼ 12 ½m þ ða=bÞ: ð4Þ
obtains also Table-1 expressions for peI , QeI and heI
(for the exponential curve) and for paI 
, QaI and haI Combining (4) with (1a)–(1c) and (3) gives
(for the algebraic curve). 
plR ¼ ½m þ ð3a=bÞ=4; ð5aÞ
The above results show that linear, iso-elastic
and exponential demand curves lead to quite dif- QlR ¼ ða  bmÞ=4; ð5bÞ
ferent solutions. Specifically, a linear demand
curve requires m < ða=bÞ for a positive retailerÕs hlR ¼ ða  bmÞ2 =ð16bÞ; ð5cÞ
profit; but the iso-elastic and exponential curves
will always lead to some positive profit no matter hlM ¼ ða  bm2 Þ=ð8bÞ: ð5dÞ
how high m is. Also, while the linear and expo-
nential curves never produce nonsensical solu- Comparing the integrated-systemÕs (1a)–(1c) with
tions, the iso-elastic curve will always produce the two-echelon systemÕs (5a)–(5d) shows that
nonsensical solution when a 6 1. The algebraic QlI =QlR ¼ 2; ð6aÞ
curve has the same qualitative properties as the
iso-elastic curve. hlM =hlR ¼ 2; ð6bÞ
534 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548

and ðchannel efficiencyÞlinear ¼ CEl
¼ ½ðhlR þ hlM Þ=hlI  ¼ 0:75:
That is, regardless of the values of a, b (supposedly
pertaining to market characteristics) and m, the
manufacturerÕs profit will always be exactly twice
the retailerÕs profit, and the channel efficiency will
always be 0.75. Those preceding results that are
relevant for subsequent discussions are summa-
rized in Table 2. Using the same procedure,
one obtains corresponding expressions for the
exponential, iso-elastic and algebraic curves, also
summarized in Table 2.
Most related two-echelon price-sensitive-
demand Stackelberg models incorporate in their h
(profit) functions various other factors such as
carrying and fixed order costs (as in Parlar and
Wang, 1994; Weng, 1995), stochastic demand (as
in Emmons and Gilbert, 1998) and/or information
asymmetry (as in Chu and Messinger, 1997), to
name but a few. The models in this paper incor-
porate none of these factors because we need to
isolate and highlight the effects of the form of the
demand-curve; ultimately, our results on these ef-
fects will demonstrate that their interaction with
other factors should be carefully considered in
formulating multiple-factor multi-echelon systems.
3.2. Comments on the results in Table 2
Some of the more commonly investigated issues
in a multiple-echelon system are its channel effi-
Table 2
Summary of two-echelon formulas
Linear Exponential
 
w 
m þ ab bm þ 1
2 b
 
m þ 3ab bm þ 2
p
4 b
a  bm
Q ceðbmþ2Þ
4 a
ciency and the relative profitabilities of the various
echelons. For example, one might be interested in
ð6cÞ
how a certain quantity-discount scheme or pattern
of market-information asymmetry might affect the
relative profits of the manufacturer and the re-
tailer. In these investigations, if the retailer gets to
set the retail price, then one might pick any one of
the common price–demand curves and then pro-
ceed with the analyses on the effects of factors of
interest.
However, the last row of Table 2 shows that,
without incorporating additional factors such as
quantity discounts and information asymmetry,
the form of the demand curve has a very definite
effect on the profitability ratio hM =hR of a simple
deterministic two-echelon system. Some com-
ments/questions that arise from examining the last
row in Table 2 are:
(a) It was not intuitively obvious that the form of
the demand curve would have a definite effect
on ðhM =hR Þ.
(b) Even after recognizing that the demand-
curve format affects ðhM =hR Þ; it is surprising
that this ratio can only be 2 (or 1) if the de-
mand curve is linear (or exponential), and that
the ratio must be less than 1 for an iso-elastic
curve.
(c) Could there be demand curves producing a
ðhM =hR Þ-value of (say) 1.5 or 2.5?
(d) If in a certain supply-chain model a factor such
as information asymmetry affects ðhM =hR Þ in a
Iso-elastic ða > 1Þ Algebraic ða > 1Þ
 
am am þ bk
a1 ah  1 i
a2 m a2 m þ bð2a1Þ
k
ða  1Þ2 ða  1Þ2
 2a  2a
a1 K a1
1
ðkmþbÞa
ma a

Channel 3
4
¼ 0:75 0:736ð¼ 2e1 Þ ¼ ð2a  1Þ½ða  1Þða1Þ =aa , ¼ ð2a  1Þ½ða  1Þða1Þ =aa ,
efficiency which varies from 1 (when which varies from 1 (when
a ! 1) to 0.736 (when a ! 1Þ a ! 1) to 0.736 (when a ! 1)
   
hM =hR Constant ¼ 2 Constant ¼ 1 Varies; <1; ¼ 1  1a ; Varies; <1; ¼ 1  1a ;
¼ 0.5 if a ¼ 2 ¼ 0.5 if a ¼ 2
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548
certain pattern under (say) a linear-demand-
curve assumption, it is not intuitively obvious
anymore that the same pattern might apply
under (say) an iso-elastic-curve assumption.
Consider now channel efficiency (‘‘CE’’). The
second-to-last row of Table 2 shows that CEl ¼
0:75 and CEe ¼ 0:736 always. The iso-elastic
ða1Þ
CEc -function [ða  1Þ ð2a  1Þ=aa ] is plotted
in Fig. 1. As a increases beyond 2, CEc ap-
proaches 0.736 (¼CEe ). For smaller a-values,
CEc approaches 1! It is well-known that most
non-integrated supply-chain systems derive less
channel profit than their corresponding inte-
grated systems. However, Fig. 1 shows that un-
der an iso-elastic curve with a sufficiently close to
1, high channel efficiencies are achieved through
the manufacturerÕs and retailerÕs entirely self-
benefiting pricing decisions which are made
without any consideration of channel efficiency.
Moreover, CE is never less than 0.736. Parallel
to the preceding paragraph and recognizing now
the unexpected definite effect of the form of the
demand-curve on CE, two questions at this stage
are:
(i) could there be demand curves producing a CE
less than 0.736?
(ii) if the CE of a more complex supply chain (e.g.,
one with stochastic demands, asymmetric in-
formation, etc.) is shown to deteriorate rap-
idly under (say) a linear demand curve, does
it necessarily mean that the CE will similarly
deteriorate under an iso-elastic curve having
a close-to-1 a-value?
Fig. 1. Plot of CEc versus a.
535
The last two columns of Table 2 indicate that
the iso-elastic and algebraic curves have identical
results on CE and ðhM =hR Þ; this can be explained
by the fact that the two curves have essentially the
same shape, even though the algebraic curve is not
iso-elastic over p. We have found that the two
curves have the same behavior on all the multi-
echelon issues we are interested in this study,
therefore the algebraic curve will be dropped from
now on.
4. The three-echelon situation
Extending the analyses in Section 3, we now
consider the three-echelon system defined in Sec-
tion 1, where the manufacturer first sets the
wholesale price W to be charged to a wholesaler,
the wholesaler responds by charging the retailer w,
then the retailer responds with Q and p.
4.1. Derivation of basic results
Consider first the linear demand curve d ¼ Q ¼
a  bp. Assume that the manufacturer has already
set W. The wholesaler knows that for any w-value
he sets, the retailer will purchase Ql ¼ ða  bwÞ=2
(according to (1b)), hence the wholesalerÕs profit
will be
hlW ¼ Ql ðw  mÞ ¼ ða  bwÞðw  W Þ=2: ð7Þ
Solving ‘‘dhlW =dw ¼ 0’’ gives the optimal whole-
sale price set by the wholesaler as
wl ¼ 12½W þ ða=bÞ: ð8Þ
Combining (8) and (1a)–(1c) gives, for any set W-
value:
plR ¼ ½W þ ð3a=bÞ=4; ð9aÞ
QlR ¼ ða  bW Þ=4: ð9bÞ
Hence for any W set by the manufacturer, his
profit will be
hlM ¼ Ql ðW  mÞ ¼ ða  bW ÞðW  mÞ=4: ð10Þ
Solving ‘‘dhlM =dW ¼ 0’’ gives the optimal whole-
sale price set by the manufacturer as
Wl ¼ 12½m þ ða=bÞ: ð11Þ
536 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548

Combining (8)–(11) gives Those preceding results that are relevant for sub-
sequent discussions are summarized in Table 3.
wl ¼ ½m þ ð3a=bÞ=4; ð12aÞ Using the same procedure, one obtains corre-

sponding expressions for the exponential and iso-
plR ¼ ½m þ ð7a=bÞ=8; ð12bÞ elastic curves, also summarized in Table 3. The
preceding methodology can be easily extended to
QlR ¼ ða  bmÞ=8; ð12cÞ
four or more echelons; in any case most of the
2 results for four or more echelons can be easily
hlR ¼ ða  bmÞ =ð64bÞ; ð12dÞ surmised by observing the evolutionary pattern
2 from Tables 1–3, e.g., p for an n-echelon system
hlW ¼ ða  bmÞ =ð32bÞ; ð12eÞ under the iso-elastic curve will obviously be
n
an m=ða  1Þ .
hlM ¼ ða  bmÞ2 =ð16bÞ: ð12fÞ Some properties revealed by comparing Tables
Similar to (6b), here each echelonÕs profit will be 1–3 are:
exactly twice that of the immediately follow-
ing echelon, regardless of the values of a, b and m; 1. Starting from the first echelon (the echelon fur-
i.e., thest from the consumer), the profit-maximizing
hlM =hlW ¼ hlW =hlR ¼ 2; and hlM =hlR ¼ 4: ð13Þ price an echelon should charge is unaffected by
the number of echelons to be added below.
Also, regardless of the values of a and b, one has Thus, the optimal first-echelon price is p in
QlI =QlR ¼ 4 ð14Þ Table 1, w in Table 2 and W  in Table 3, and
they are all same. Similarly, p in Table 2 is
and the same as w in Table 3.
2. Table 3 reveals that the optimal prices at differ-
ðchannel efficiencyÞlinear ¼ CEl ent echelons (i.e., W  , w and p ) differ by: (i) a
¼ ½ðhlR þ hlW þ hlM Þ=hlI  ¼ 7=16 ¼ 0:4375: constant multiplicative factor [a=ða  1Þ] under
ð15Þ the iso-elastic curve; (ii) a constant additive

Table 3
Summary of three-echelon formulas
Linear Exponential Iso-elastic
d ¼ a  bp d ¼ c expðbpÞ d ¼ Kpa
 
W m þ ab 1 am
mþ
 2 3a b a1
mþ b 2 a2 m
w mþ
4 b ða  1Þ2
 
m þ 7ab 3 a3 m
p mþ
8 b ða  1Þ3
 3a
a  bm a1 K
Q ceðbmþ3 Þ
8 a ma
7
Channel efficiency ¼ 0:4375 0:406ð¼ 3e2 Þ ¼ ð3a2  3a  1Þ½ða  1Þða1Þ =aa 2 , which varies
16
from 1 (when a ! 1) to 0.406 (when a ! 1)
 
hM =hW Constant ¼ 2 Constant ¼ 1 Varies, <1; ¼ 1  1a ; ¼ 0.5 if a ¼ 2
 
hW =hR Constant ¼ 2 Constant ¼ 1 Varies, <1; ¼ 1  1a ; ¼ 0.5 if a ¼ 2
 
hM =hR Constant ¼ 4 Constant ¼ 1 Varies, <1; ¼ 1  1a ; ¼ 0.25 if a ¼ 2
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548
factor ð1=bÞ under the exponential curve; and
(iii) and non-constant additive factor under
the linear curve.
The last row of Table 3 illustrates another
danger of using any ‘‘convenient’’ downward-
sloping demand curve arbitrarily. As the number
of intermediate echelons increases, had the linear
curve been used, one would conclude that the
manufacturerÕs profit becomes increasing larger
than the retailerÕs; but had the iso-elastic curve
been used, one would reach exactly the opposite
conclusion.
In the following sections some of the unex-
pected results presented earlier are further exam-
ined.
5. An often overlooked property of the linear
demand curve
This section explains why (as depicted in Tables
2 and 3) the answers for dimensionless ratios such
as CEl and hlM =hlR cannot be changed by varying
the values of the parameters a and b in a linear
demand curve d ¼ a  bp. Consider the curves
d1 ðin tonsÞ ¼ 10  2p (p in $) and d2 ðin tonsÞ ¼
10  1p (p in $); both curves are specified with the
same quantity and monetary units. The two curves
of course describe two different markets; e.g.,
d1 ¼ 8 tons but d2 ¼ 9 tons when p ¼ $1. However,
consider d1 ¼ 10  2p with no measurement units
specified initially. If it is then known that the
measurement units in the d1 -curve are ‘‘tons’’ and
‘‘$’’, it is obvious that by declaring an arbitrary
monetary unit taler and an exchange rate of $1 ¼
2 talers, the demand curve ‘‘d3 ¼ 10  1p’’ with
‘‘p ’’ now in taler describes the same market as the
d1 -curve. The following subsection shows formally
that linear demand functions with arbitrarily dif-
ferent (a, b)-values can be made to represent exactly
the same market by simply declaring suitably dif-
ferent quantity and/or monetary units. Therefore,
linear demand curves with different a and b values
can only lead to different answers in dimensioned
values such as optimal prices and quantities, but
will lead to identical answers for dimensionless ra-
tios such as CEl and hlM =hlR .
537
5.1. Proof that ‘‘d ¼ a  bp’’ can represent the same
market condition for any (a, b)-value
Consider an ‘‘initial’’ demand function ‘‘d1 ¼
a  bp1 ’’ where the quantity-measurement unit for
q1 is in ‘‘ton’’ and p1 Õs monetary unit is ‘‘$’’.
Consider another demand function ‘‘d2 ¼ A  Bp2 ’’
with arbitrarily assigned values of A and B. Now,
for arbitrary quantity-measurement unit ‘‘stone’’
and monetary unit ‘‘taler’’, define the conversion
rates 1 taler ¼ $/ and 1 stone ¼ w ton. It is ob-
vious that the ‘‘initial’’ demand function can be
rewritten as:
q2 ¼ ða  bp1 Þ=w ¼ ða=wÞ  ðbp1 =wÞ (q2 in new
unit ‘‘stone’’, but p1 in old ‘‘$’’);
and then as:
q2 ¼ ða=wÞ  ½b/p2 =w (both q2 and p2 in new
units ‘‘stone’’ and ‘‘taler’’, respectively).
Thus, given any initial demand function ‘‘q2 ¼
a  bp’’, it can be converted to ‘‘q ¼ A  Bp’’
having any arbitrarily required (A,B) values by
setting ða=wÞ ¼ A and ½b/=w ¼ B; i.e., by simply
defining alternative monetary and quantity units
with conversion rates w ¼ a=A and / ¼ Bw=b.
5.2. Extensions
It can be similarly shown that c and b in the
exponential curve ‘‘d ¼ c expðbpÞ’’ can take
any arbitrarily-specified values by changing the
monetary and quantity units. That is, seem-
ingly different exponential curves can be made to
correspond to the same price–quantity relation-
ship, therefore they lead to the same answers for
such ratios as CEe and ðheM =heR Þ. In contrast, al-
though K in the iso-elastic Kpa is also merely a
scaling factor, different a-values do represent gen-
uinely different price/demand relationships, hence
different a-values can lead to different optimal
answers for ratio indicators. By the same token, in
a
the algebraic curve ‘‘d ¼ ½ðkp þ bÞ ’’ the para-
meter k is also a scaling factor; however, b is
not a scaling factor and different b-values ap-
pear to represent different market conditions,
and it is interesting but somewhat surprising that
the algebraic and iso-elastic curves affect the ech-
elon-related dimensionless ratios in the same
way.
538 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548
6. Combining linear and iso-elastic demand curves
6.1. Confirming the earlier results and achieving a
wider range of (hM =hR ) and CE values
We showed above that the manufacturerÕs
profit always exceeds the retailerÕs if the demand
curve is linear, but exactly the opposite is true if
the demand curve is iso-elastic. Also, Table 2
shows that ðhM =hR Þ can only be either 2, 1 or less
than 1; but not (say) 1.5. Is there an error some-
where? Since the linear (iso-elastic) curve gives the
highest (lowest) ðhM =hR Þ-value, what happens if the
demand curve is ‘‘somewhat between’’ a linear and
an iso-elastic curve? One way to answer the above
questions is to consider a ‘‘hybrid curve’’ formed
by mixing a ‘‘pure’’ linear curve ða  bpÞ with a
‘‘pure’’ iso-elastic curve Kpa in the form of:
d ¼ sða  bpÞ þ ð1  sÞKpa ;
where s is the mixture-ratio: ð16Þ
If the earlier results on ðhM =hR Þ are correct, one
would expect that (16) will produce results ap-
proaching that of the linear (or iso-elastic) curve as
‘‘s’’ in (16) approaches ‘‘1’’ (or ‘‘0’’). Also, if this
expectation is confirmed, it would also provide a
demand curve that can produce a ðhM =hR Þ-value of
(say) 1.5.
If (16) is to be fitted to actual price–demand
data, then the values of its five parameters (s, a, b,
K, a) would be determined by the curve-fitting
algorithm and its associated goodness-of-fit crite-
ria (similar in spirit to the empirical demand-curve
fitting cited in Section 1.1). However, in this dis-
cussion we are interested in Table-2-type proper-
ties of the hybrid function (i.e., Eq. (16)), and in
our limited space we need to decide what combi-
nations of (s, a, b, K, a)-values we want to inves-
tigate. Consider first the values of (a, b, K, a),
which define the two (composing) pure curves. In
(16) there is no requirement as to whether the two
pure curves to be mixed should be very different
(i.e., they are physically far apart when plotted on
a graph) or ‘‘somewhat similar’’ (i.e., they are close
to each other on a graph). For reasons that will be
explained at the end of Section 6.2, we will start
our investigation by mixing two pure curves that
are ‘‘similar’’ to each other. Among the many
possible criteria for defining ‘‘similarity’’ between
a linear and an iso-elastic curve (which after all can
cross each other at no more than two points), we
will (as a starting point) use two pure curves that
would have produced the same profit individually
in a one-echelon system. Referring to (1c) and the
corresponding hcI -formula given in Table 1, this
means that the pure curvesÕ parameters should be
2 a1
such that ða  bmÞ =ð4bÞ ¼ Kða  1Þ =½aa ma1 ,
or
K ¼ aa ma1 ða  bmÞ2 =½4bða  1Þa1 : ð17Þ
Since we showed in Section 5 that all (a, b)-values
in the linear curve amount to the same market
behavior, we arbitrarily set a ¼ 10 and b ¼ 1. For
each set a-value of the iso-elastic curve, the re-
quired K-value is then given by (17).
For a two-echelon system (as considered in
Section 3) with (16) as the demand curve, analyt-
ical solutions are available only for the cases of
s ¼ 0 or 1 (as tabulated in Table 2). For 0 < s < 1,
the problem is solved numerically as a dynamic
programming problem (the FORTRAN program
can be obtained from the authors). The effective-
ness of this numerical procedure deteriorates rap-
idly as the number of echelons increases, therefore
from now on only a two-echelon system will be
considered.
Table 4 depicts the results for the hybrid curve
(16) with a ¼ 5, m ¼ 5 and hence (from (17))
K ¼ 47683:7. The ðhhM =hhR Þs (fourth column from
the left) confirm our earlier conjectures; i.e., the
ðhhM =hhR Þs change smoothly from the iso-elastic-
curve value of 0.80 to the linear-curve value of 2.00
as s increases from 0.0 to 1.0. By adjusting the s-
value, any ðhhM =hhR Þ-value between 0.80 and 2.00
can be realized. A unexpected bonus is that the
Table 6 CEs for some of the s-values are less than
the minimum possible CE-value (i.e., 0.736) shown
in Table 2. Thus, some of the questions raised in
Section 3.2 have been partially answered; specifi-
cally, (i) values of ðhM =hR Þ and CE need NOT be
restricted to those depicted in Table 2; (ii) pre-
sented is a method for constructing mathematical
demand-curve functions that can have values of
ðhM =hR Þ and CE other than those depicted in Table
2 (particularly, with CE-values below 0.736).
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548 539

Table 4
Variation of ðhhM =hhR Þ and other properties with the mixture ratio s (a ¼ 5, m ¼ 5, K ¼ 47683:715)
s Two-stage system CE Integrated system
hhM hhR hhM =hhR whM 
phR QhR hhI 
phI QhI
0.0 2.05 2.56 0.80 6.25 7.81 1.64 0.74 6.25 6.25 5.00
0.1 2.06 2.18 0.94 6.57 8.23 1.31 0.70 6.10 6.34 4.56
0.2 2.15 1.78 1.21 6.96 8.59 1.10 0.66 5.98 6.45 4.13
0.3 2.28 1.62 1.41 7.17 8.71 1.05 0.66 5.90 6.59 3.72
0.4 2.41 1.56 1.55 7.28 8.75 1.06 0.68 5.85 6.75 3.35
0.5 2.54 1.54 1.65 7.36 8.78 1.07 0.69 5.84 6.92 3.04
0.6 2.66 1.53 1.74 7.39 8.77 1.11 0.71 5.87 7.08 2.82
0.7 2.78 1.51 1.84 7.44 8.77 1.14 0.72 5.94 7.22 2.67
0.8 2.90 1.52 1.90 7.47 8.76 1.17 0.73 6.03 7.33 2.58
0.9 3.01 1.55 1.94 7.48 8.75 1.21 0.74 6.13 7.43 2.53
1.0 3.13 1.56 2.00 7.50 8.75 1.25 0.75 6.25 7.50 2.50

6.2. Additional complications
However, while the ‘‘well-behaved’’ figures in
Table 4 resolved some of our earlier questions, it
hides other complications that surfaced in our use
of hybrid curves. It turns out that Table 4 is the
result of constructing a large number of similar
tables corresponding to many different combina-
tions of a and m values and then selecting one of
the ‘‘best-looking’’ tables. An alternative but ac-
tually more common appearance is Table 5, for the
case of a ¼ 1:2 and m ¼ 1 (hence K ¼ 34:773 ac-
cording to Eq. (17)). The first block of 11 rows in
Table 5 (with s from 0 to 1 in steps of 0.1) shows
that ðhhM =hhR Þ jumps from 0.17 to 1.54 when s
increases from 0.0 to 0.1. The intuitive assumption
at this stage is that ðhhM =hhR Þ would increase more
smoothly within the s-range of 0.0–0.1, and that
ðhhM =hhR Þ-values between 0.17 and 1.54 can be
easily obtained by adjusting the s-value in the
range of 0.0–0.1. This assumption is refuted by
second block of 11 rows in Table 5 (with s from 0.0
to 0.1 in steps of 0.01), where not only ðhhM =hhR Þ
jumps from 0.17 to 1.35, but whM also jumps from
6 to 17.07 when s increases from 0.00 to 0.01.
Table 5Õs third block (where s increases from 0.00
to 0.01 in steps of 0.001) is even more disturbing,
with ðhhM =hhR Þ jumping from 0.17 to 1.28 and whM
jumping from 6 to 41.79 (!) when s increases from
0.000 to 0.001. The ‘‘jumps’’ in the values of hhM ,
hhR , phR

, QhR and CE when s increase from 0 to 0.1
(or to 0.01 and 0.001) are equally peculiar; spe-
cifically, note the record-low (in this study) CE-
value of 0.49 when s ¼ 0:001 (in contrast to the
lowest possible CE of 0.736 depicted in Table 2).
On the other hand, the right-hand-side of Table 5
shows that, consistent with intuitive expectation,
there are no sudden jumps when the hybrid curves
are used in a one-echelon system (the more usual
scenario in which demand curves are used). Also,
hhI remains essentially unchanged (recall that we
set K such that the two ‘‘pure’’ curves have the
same hI ), and phI

changes very little as s varies over
the entire range of 0 to 1, in sharp contrast with
the wide fluctuations of the two-echelonÕs hhM , hhR

and phR .
Section 6.3 will explain how these seemingly
incorrect answers arise. At this juncture, assuming
for the time being that the above peculiar results
are correct, the preceding results demonstrate that
very small changes in a demand curve can lead to
unexpectedly large differences in the ‘‘correct so-
lutions’’ of a two-echelon system, while the dif-
ferences in the correct solutions of a single-echelon
system would be very small (consistent with intu-
ition). Fig. 2 graph the demand curves with s ¼ 0
and 0.001, as considered in Table 5 (recall that
a ¼ 1:2, m ¼ 1 and K ¼ 34:773). Fig. 2a shows
them for the range of p ¼ 1 to 100; the two curves
are essentially one. Fig. 2b shows them for p ¼ 10
to 100; only now is the difference between the two
curves barely discernable (the lower curve is the
one with s ¼ 0:001). The very small difference in
the curvesÕ appearances belie the large effect of this
540 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548

Table 5
Variation of ðhhM =hhR Þ and other properties with the mixture ratio s (a ¼ 1:2, m ¼ 1, K ¼ 34:773)
s Two-echelon system CE Integreted system
hhM hhR hhM =hhR whM 
phR QhR hhI 
phI QhI
0 2.36 14.15 0:17 6.00 36.00 0.47 0.82 20.25 6.00 4.05
0.1 8.12 5.28 1:54 8.38 13.18 1.10 0.66 20.24 5.70 4.30
0.2 8.63 5.21 1.66 7.19 10.92 1.39 0.68 20.24 5.62 4.38
0.3 8.96 5.23 1.71 6.60 9.87 1.60 0.70 20.24 5.58 4.42
0.4 9.21 5.17 1.78 6.29 9.25 1.74 0.71 20.24 5.55 4.44
0.5 9.42 5.12 1.84 6.07 8.83 1.86 0.72 20.24 5.54 4.46
0.6 9.60 5.13 1.87 5.89 8.51 1.96 0.73 20.24 5.53 4.47
0.7 9.75 5.17 1.89 5.73 8.24 2.06 0.74 20.24 5.52 4.48
0.8 9.89 5.01 1.97 5.70 8.08 2.10 0.74 20.25 5.51 4.49
0.9 10.01 5.07 1.97 5.57 7.89 2.19 0.74 20.25 5.51 4.49
1 10.12 5.06 2.00 5.50 7.75 2.25 0.75 20.25 5.50 4.50
0 2.36 14.15 0:17 6.00 36.00 0.47 0.82 20.25 6.00 4.05
0.01 6.71 4.96 1:35 17.07 28.94 0.42 0.58 20.25 5.93 4.10
0.02 7.10 5.14 1.38 13.37 22.33 0.57 0.60 20.25 5.89 4.14
0.03 7.34 5.15 1.42 11.81 19.40 0.68 0.62 20.24 5.85 4.17
0.04 7.51 5.12 1.47 10.90 17.66 0.76 0.62 20.24 5.82 4.20
0.05 7.65 5.17 1.48 10.18 16.38 0.83 0.63 20.24 5.79 4.23
0.06 7.77 5.20 1.49 9.65 15.44 0.90 0.64 20.24 5.77 4.25
0.07 7.87 5.19 1.52 9.28 14.73 0.95 0.65 20.24 5.75 4.26
0.08 7.96 5.19 1.53 8.95 14.14 1.00 0.65 20.24 5.73 4.28
0.09 8.04 5.25 1.53 8.63 13.61 1.05 0.66 20.24 5.72 4.29
0.1 8.12 5.28 1.54 8.38 13.18 1.10 0.66 20.24 5.70 4.30
0 2.36 14.15 0:17 6.00 36.00 0.47 0.82 20.25 6.00 4.05
0.001 5.53 4.33 1:28 41.79 73.75 0.14 0.49 20.25 5.99 4.06
0.002 5.86 4.43 1.32 32.04 55.51 0.19 0.51 20.25 5.99 4.06
0.003 6.07 4.62 1.31 26.96 46.72 0.23 0.53 20.25 5.98 4.07
0.004 6.22 4.76 1.31 23.89 41.40 0.27 0.54 20.25 5.97 4.07
0.005 6.34 4.80 1.32 21.98 37.89 0.30 0.55 20.25 5.97 4.08
0.006 6.43 4.81 1.34 20.64 35.34 0.33 0.56 20.25 5.96 4.08
0.007 6.51 4.85 1.34 19.49 33.26 0.35 0.56 20.25 5.95 4.09
0.008 6.59 4.85 1.36 18.63 31.63 0.37 0.56 20.25 5.95 4.09
0.009 6.65 4.95 1.34 17.68 30.10 0.40 0.57 20.25 5.94 4.10
0.01 6.71 4.96 1.35 17.07 28.94 0.42 0.58 20.25 5.93 4.10

difference on a two-echelon system, as depicted in curveÕs Table 2-type properties is outside the scope
the first two rows of the second and third blocks of of this paper.
Table 5.
We stated earlier with (17) that we have used
‘‘similar’’ pure curves to form the hybrids, other- 6.3. A closer look on how the demand curves affect
wise it might appear that the peculiar behavior hhM , hhR and phR


depicted in Table 5 is due to the use of ‘‘non-

similar’’ pure curves or some ‘‘tricky’’ combina-
tions of (s, a, b, K)-values. Actually, regardless of
whether K follows (17), we obtained hybrid curves
that display both Tables 4 and 5 behavior. A more
detailed investigation of how different combina-
tions of (s, a, b, K, a)-values affect the hybrid-
Fig. 3a shows how the manufacturerÕs and re-
tailerÕs profits ðhhM and hhR Þ vary with retail price p
when the wholesale price is fixed at w ¼ 6 and the
demand curve is according to (16) but with s ¼ 0
(i.e., a pure iso-elastic curve). It illustrates how
the system arrives at the optimum ‘‘hhM ¼ 2:36’’
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548 541

Fig. 2. Comparison of two curves, d ¼ bða  bpÞ þ ð1  bÞK=paa . Range of p: (a) 1–100; (b) 10–100.

when w ¼ 6 (see the row for s ¼ 0 in Table 5): the
retailer chooses the p-value at which the hhR -curve
peaks, which is p ¼ 36, and at this p-value the hhM -
curve has a value of 2.36. Fig. 3b is the counterpart
of Fig. 3a for s ¼ 0:001. Here the hhR -curve peaks
at p ¼ 27:6, with a corresponding hhM ¼ 3:15. Figs.
4 and 5 are counterparts of Fig. 3 for the cases of
w ¼ 16 and 41.79, respectively; the hhR -maximizing
p-values and the corresponding hhM values shown
in Figs. 3–5 are also tabulated in Table 6 (only 3 of
the w-values tabulated in Table 6 are graphed in
Figs. 3–5).
The peculiar solutions described in Section 6.2
can now be explained as follows. In Fig. 2b, the
demand (d) curve with s ¼ 0:001 deviates visibly
from and dips slightly below the curve with s ¼ 0
at the high-p range; although the magnitudes of
these deviations are very small, the corresponding
d-values are also very small; hence the percentage
deviations in d are quite large. Therefore, in Fig. 3,
542 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548

Fig. 3. Variation of hhM and hhR with p for two different demand curves w ¼ 6. (a) b ¼ 0; (b) b ¼ 0:001.

the right-hand dip of the hhR curve for s ¼ 0:001
(Fig. 3b) starts earlier (i.e., at a lower p-value) and
is much more conspicuous than the right-hand dip
of the hhR curve for s ¼ 0 (Fig. 3a), even though
the hhM curves in Fig. 3a and b are very similar (so
are the left-hand-sides of the hhR curves). There-
fore, if w is set at a relatively high value (above 6),
the fast-dipping hhR curves for s ¼ 0:001 (see Figs.
4b and 5b) can prevent the retailer from setting
much higher p-values, thus enabling the manu-
facturer to benefit from the high w value because
the not-much-higher p has not reduced Q that
much. In contrast, when s ¼ 0, if w is set above 6,
the slow-dipping hhR curves enable the retailer to
set much higher p-values, hence Q decreases sub-
stantially, which in turn is why the manufacturerÕs
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548 543

Fig. 4. Variation of hhM and hhR with p for two different demand curves w ¼ 16. (a) b ¼ 0; (b) b ¼ 0:001.

hhM decreases rapidly as p increases. This dis-
courages the manufacturer to raise w, and explains
why w ¼ 6 and ðhhM =hhR Þ ¼ 0:17 under s ¼ 0, but
w jumps to 41.79 and ðhhM =hhR Þ jumps to 1.28
when s ¼ 0:001.
Now that the Table 5 solutions are shown to
be mathematically correct, they reveal potential
problems in modeling multiple-echelon inventory
systems as well as directions for further research in
specifying demand curves. Among them are:
1. Assume that market data suggests a demand
curve ‘‘something like’’ the curves shown in
Fig. 2. Even with extensive empirical data, it
would be difficult to tell which of the two curves
in Fig. 2 describe the market more correctly;
544 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548

Fig. 5. Variation of hhM and hhR with p for two different demand curves w ¼ 41:79. (a) b ¼ 0; (b) b ¼ 0:001.

however, different curves lead to very different
two-echelon optimal decisions. Thus, if the cor-
rect curve is s ¼ 0 but the manufacturer incor-
rectly assumed s ¼ 0:001, his incorrect optimal
w of 41.79 would return a profit that is only
1.87 (see the row for w ¼ 41:79 in Table 6); i.e.,
only one third of the originally expected 5.53.
2. Actually, as mentioned in Section 1.1, most em-
pirical demand-curve estimations start out by
assuming a certain form (typically the iso-elastic
form), and there is little chance of ‘‘discover-
ing’’ that the actual demand curve might follow
a different form.
3. Since a very small difference in the assumed de-
mand curve can lead to very large differences in
the final answers, one can no longer blissfully
assume that multi-echelon-model results ob-
tained under one demand-curve assumption
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548 545

Table 6
Optimal values of hhR , p, Q and hhM for given values of w; s ¼ 0 and 0.001 (a ¼ 1:2, m ¼ 1, K ¼ 34:773)
w s¼0 s ¼ 0:001
hhR p Q hhM hhR p Q hhM
4 15.4 24 0.77 2.30 15.1 20.8 0.90 2.69
6 14.2 36 0.47 2:36 13.6 27.6 0.63 3.15
10 12.8 60 0.26 2.30 11.6 37.4 0.42 3.81
16 11.6 96 0.15 2.18 9.5 47.5 0.30 4.51
31 10.2 186 0.07 1.97 6.0 64.5 0.18 5.38
41.79 9.6 250.7 0.05 1.87 4.3 73.7 0.14 5:53
45 9.5 270 0.04 1.85 3.9 76.2 0.13 5.51

are applicable under alternative demand-curve
assumptions. This point is numerically illus-
trated below.
7. An illustration of the effect of assuming different
demand curves
now on). Hence the uncoordinated channelÕs effi-
ciency is 75%. Chopra and Meindl point out that a
100% CE can be achieved if the manufacturer offers
the retailer the following quantity discount scheme:
ðiÞ regular wholesale price
wreg ¼ 4 if Q < 120;000; ð21aÞ

We will consider the Chopra and Meindl (2001, ðiiÞ discounted wholesale price
pp. 160–161) model because it: (i) illustrates ef-
wdis ¼ 3:5 if Q P 120;000: ð21bÞ
fectively an important supply-chain concept (i.e.,
using quantity discount to improve channel effi- This is because under this discount scheme the
ciency); (ii) is sufficiently simple to be discussed retailerÕs optimal action is to order Q ¼ 120;000
as one short section in this paper; (iii) is presented (¼ QI , see (19)) and charge p ¼ 4 (¼ pI ); his profit
in a new and well-received graduate-level supply will be
chain management textbook.
We will first summarize Chopra–MeindlÕs pre- QI ðpI  wdis Þ ¼ 120;000ð4  3:5Þ ¼ 60;000 ð22Þ
sentation of their quantity discount scheme for the which is the same as hR
shown in (20). At the
two-echelon system defined in our Section 3. The same time, since Q ¼ 120;000 ¼ QI (see (19)), the
situationÕs parameters are: channel profit now equals the integrated-firmÕs
profit.
Situation A: demand curve is d ¼ a  bp
Note that the above quantity-discount scheme
¼ 360;000  60;000p; and m ¼ 2: ð18Þ can be generalized as follows:
Using (1a)–(1c), (4) and (5a)–(5d), one obtains: ðaÞ Charge regular wholesale price
for the integrated firm: wreg ¼ w ðsee ð20Þ and ð21ÞÞ ifQ < QI :
pI ¼ 4; QI ¼ 120;000; and hI ¼ 240;000; ð23aÞ
ð19Þ
ðbÞ Charge discount price wdis if Q P QI ;
for the uncoordinated two-echelon channel:
where wdis is determined by solving the equa-
w ¼ 4; pR ¼ 5; QR ¼ 60;000; tion QI ðpI  wdis Þ ¼ hR ðsee ð22ÞÞ: ð23bÞ
hR ¼ 60;000; hM ¼ 120;000 and
hC ¼ hR þ hM ¼ 180;000 ð20Þ The question we now ask is: does this quantity-
discount scheme (23a) and (23b) work for other
(note that the demand-curve identifying subscript ‘‘situations’’ (e.g.; with other demand functions
of such variables as w and hR will not be used from or with the same (linear) demand function but
546 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548

different parameter-values). As numerical exam-
ples, we now implement this scheme to Situations
B, C and D (defined below), all with m ¼ 1:
(B) demand curve d ¼ 360;000  60;000p (same
as (18)), m ¼ 1;
(C) iso-elastic demand curve d ¼ 34:773p1:2 , as
depicted in the row for b ¼ 0 in Table 5,
m ¼ 1;
(D) hybrid curve d ¼ ½0:001ð10  pÞ þ ½0:999  Chopra–Meindl quantity-discount parameters
34:773p1:2 , as depicted in the row for s ¼
0:001 in Table 5, m ¼ 1.
The demand curves in (C) and (D) are very
close to each other (see Fig. 2), but they are very
different from the linear curve used in (A) and (B).
The results are summarized in Table 7; except for
wdis which is obtained by solving (23b), all other
answers for situations (C) and (D) are obtained by
referring to the appropriate entries in the first two
rows (for s ¼ 0 and 0.001) of the third 11-row
block in Table 5.
Theoretically, for each situation the Chopra–
Meindl scheme achieves the objective of inducing
perfect channel efficiency, but it should be obvious
that the required discounting policies for Situa-
tions (C) and (D) are quite unrealistic, because
such drastic quantity discounting as 58% or 88%
would most likely affect the manufacturerÕs credi-
bility. A better understanding of how the required
discount percentage varies with different situations
is now in order. By substituting the Tables 1 and 2
formulas into (23a) and (23b), it can be shown that
under a linear demand curve, wdis ¼ ð5bm þ 3aÞ=
8b, and the required discount percentage is



wdis 100 2bm
100 1  %¼ 1 %
wreg 4 bm þ a
which obviously can never exceed 25% (hence very
reasonable); also, it can be shown that two similar
linear demand curves will always give similar
wreg , wdis and QI (see (23a) and (23b). That is, the
scheme is a guaranteed success for any combina-
tion of (a, b, m) parameter-values under a linear
demand curve. However, for an iso-elastic demand
curve it can be shown that the required discount is
a1
100½ða  1Þ =aa %, which increases as a decreases
and approaches 100% when a approaches 1; in
other words, although a smaller a means that the
uncoordinated channel is already operating with
a CE closer to 100% (see Fig. 1), it will nevertheless
require a larger discount to move the CE to 100%!
In other words, the Chopra–Meindl scheme will
always produce reasonable discount arrangements
for linear demand curves, but can lead to very
impractical discounting arrangements for other
demand curves. On the other hand, it is obvious
that the linear curve is considerably less realistic
than the other curves considered in this study
(hence it is rarely the assumed form in empirical
demand-curve estimations).
Furthermore, recalling (from Fig. 2) that the
underlying demand curves for Situations (C) and
(D) are hardly distinguishable from each other, the

Table 7
Chopra–MeindlÕs quantity discount policy under different demand-curve assumptions
Situation Integrated system Uncoordinated system Quantity discount policy Required discount
pI QI w pR QR (from wreg to wdis ) (%)

(A) Linear curve, 4 120,000 4 5 60,000 wreg ¼ 4 if Q < 120;000 12.5%

m¼2 wdis ¼ 3:5 if Q P 120;000

(B) Linear curve, 3.5 150,000 3.5 4.75 75,000 wreg ¼ 3:5 if Q < 150;000 17.9%
m¼1 wdis ¼ 2:875 if Q P 150;000
(C) Iso-elastic 6 4.05 6 36 0.47 wreg ¼ 6 if Q < 4:05 58.2%
curve wdis ¼ 2:51 if Q P 4:05
(D) Hybrid curve 5.99 4.06 41.79 73.75 0.14 wreg ¼ 41:79 if Q < 4:06 88.2%
wdis ¼ 4:92 if Q P 4:06
 A.H.L. Lau, H.-S. Lau / European Journal of Operational Research 147 (2003) 530–548
fact that the two situations require very differ-
ent ‘‘optimal’’ discounting policies (as depicted
in Table 7) represents another obvious problem.
However, this problem is less related to the merit
of the Chopra–Meindl scheme; rather, it is an ex-
tension of the overlooked effects of demand curves
in multi-echelon systems covered in the preced-
ing sections. Nevertheless, it represents a fur-
ther burden to the design of a robust and workable
channel-coordinating quantity-discount scheme.
8. Summary and conclusion
Demand curves are often ‘‘taken for granted’’
in the sense that one picks a mathematical
price–demand function based on ‘‘convenience,’’
blissfully assuming that different plausible down-
ward-sloping price–demand functions will lead to
similar (if not identical) conclusions. In the first
part of this paper we present solutions on optimal
decisions and profits for single and multiple eche-
lon deterministic production/pricing models. These
results reveal peculiar effects of the demand-curve
format on such characteristics as channel efficiency
and inter-echelon profit ratios. Two groups of re-
sults on our attempt to explain these peculiarities
are then reported. First, an important overlooked
property of the common linear demand curve is
shown to resolve some of those peculiarities. Sec-
ond, a better understanding of some other pecu-
liarities are obtained by our formulation of a
hybrid demand curve, but this new instrument also
reveals additional fundamental but unresolved
difficulties in incorporating demand curves into
multi-echelon production/pricing models. The
most important point here is that the optimal an-
swers for a multi-echelon inventory/pricing model
can change not only substantially but also unpre-
dictably over a very small change in the demand
curve. Finally, to illustrate the potential applica-
tions of our findings, we illustrate how a textbook
model that guarantees good results under a linear
demand curve can give unrealistic and/or unreli-
able answers under more realistic demand-curve
assumptions.
The reported anomalies have not been com-
pletely resolved here. However, by establishing the
547
existence of difficulties in applying the currently
accepted demand-curve methodologies to analyze
multi-echelon production/pricing inventory sys-
tems, this paper attempts to make a first step
towards developing procedures to handle such
difficulties.
Acknowledgements
The presentations in various parts of this paper
have benefited from the detailed reviews of the
referees.
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