22-Pricing Poliies Under Direct vs. Indirect Channel Competition and National vs. Store Brand Competition

European Journal of Operational Research 180 (2007) 262–281
www.elsevier.com/locate/ejor
Production, Manufacturing and Logistics
Pricing policies under direct vs. indirect channel competition

and national vs. store brand competition
a,*
Hisashi Kurata , Dong-Qing Yao b, John J. Liu c
a
School of Business Administration, The University of Wisconsin-Milwaukee, 3202 N. Maryland Ave., Milwaukee, WI 53201, USA
b
College of Business and Economics, Towson University, 8000 York Road, Towson, MD, 21252–0001, USA
c
Department of Logistics, Hong Kong Polytechnic University, Hung Hom, Kowloon, Hong Kong
Received 10 March 2005; accepted 3 April 2006

Available online 8 June 2006
Abstract
This paper analyzes channel pricing in multiple distribution channels under competition between a national brand (NB)
and a store brand (SB), where an NB can be distributed both through a direct channel (e-channel) and an indirect channel
(local stores) but an SB can be distributed only through an indirect channel. We first explore cross-brand and cross-channel
pricing policies. Formulating the problem as a Nash pricing game, we reach two findings: (1) brand loyalty building is prof-
itable for both an NB and an SB; and (2) marketing decisions are more restrictive for an NB channel than they are for the
SB channel. We next assess supply chain coordination and reach two findings: (1) wholesale price change does not coor-
dinate the supply chain and (2) an appropriate combination of markup and markdown prices can achieve both supply
chain coordination and a win–win outcome for each channel.
2006 Elsevier B.V. All rights reserved.
Keywords: Supply chain management; Pricing; Brand management; Channel competition; Comparative statics
1. Introduction
Because of the rapid development of the Internet, interest in establishing a direct e-channel has grown
explosively among manufactures in recent years. This trend is still worth considering. However, opportunities
and threats exist when e-channels are established in addition to existing retail channels (Choi, 2003). It is
worthwhile to note that most products distributed through direct channels are national brands (NBs).
Meanwhile, in consumer goods retailing, store brands (SBs) are threatening NBs. According to a report by
the Private Label Manufacturers Association (PLMA), SBs sold in the US have become a $50 billion segment
of the retail business and have increased in strategic importance for retailers. SBs are bought by 83% of all
consumers on a regular basis and are held in high esteem by them (PLMA, 2003). Thus, managing an SB
*
Corresponding author. Tel.: +1 414 229 2543.
E-mail address: hkurata@uwm.edu (H. Kurata).
0377-2217/$ - see front matter 2006 Elsevier B.V. All rights reserved.
doi:10.1016/j.ejor.2006.04.002
H. Kurata et al. / European Journal of Operational Research 180 (2007) 262–281 263
has becomes critical for profitable retail business. Consequently, the NB vs. SB competition has become an
important marketing issue.
As competition between NBs and SBs becomes a concern, so does supply chain pricing, for both supply
chain practitioners and researchers. Many reports point out that pricing strategies in supply chain systems
contribute to higher profitability and stronger competitive power. For example, Elmaghraby and Keskinocak
(2003) mention that dynamic pricing strategies have increased in importance for the retail industry. Swamina-
than and Tayur (2003) state that with the expansion of the Internet, pricing has become a crucial concern in
supply chain management.
We started this research by asking what the optimal supply chain pricing would be if a manager considered
both direct vs. store channel competition and NB vs. SB competition. In this paper, we identify the equilib-
rium prices in the multiple channels under NB vs. SB competition and discuss how the prices behave with
respect to key marketing activities, such as advertising, brand positioning, and brand/channel loyalty. In addi-
tion, this paper explores whether there exists any pricing method that can coordinate a direct channel and a
store channel and whether there is any incentive for firms to implement such a method. Note that supply chain
coordination is defined as an increase in the total profit of the two distribution channels to the level of the max-
imum profit of the integrated system. This pricing research examines two approaches: wholesale price coordi-
nation and price markup coordination.
Many researchers have studied SB management, price competition, and distribution channels. As for the
two-manufacturer and one-retailer supply chain, Choi (1991) analyzed competition between an NB and an
SB using three game theoretic models: a manufacturer-leader Stackelberg game, a retailer-leader Stackelberg
game, and a vertical Nash game. Using an analytical model with two or more NBs and an SB, Raju et al.
(1995) researched the effect of cross-price sensitivity and potential market size on the profitability of selling
or introducing an SB. Sethuraman and Cole (1999) empirically studied the price premium that customers
pay for an NB over an SB. Sayman et al. (2002) explored the positioning of SBs using a game theoretic
approach. They analyzed three brands—a strong NB, a weak NB, and an SB—and found that the SB should
mimic the stronger NB.
Our paper makes a unique contribution to supply chain management under NB vs. SB competition in three
ways. First, while most supply chain papers explore either vertical decisions (e.g., coordination between a
manufacturer and a retailer) or horizontal decisions (e.g., pricing between the two stores), our model examines
both horizontal and vertical decisions. Our model includes an NB controlled by a manufacturer and an SB
controlled by a retailer. To the best of our knowledge, no previous supply chain research has studied both
channel and NB vs. SB competition simultaneously. Second, this paper connects the obtained analytical
results with marketing activities from a consumer behavior perspective. This serves as a theoretical foundation
to identify pragmatic business implications that might assist real marketing management. Specifically, our
paper differentiates best marketing strategy planning in NBs and SBs. Finally, this study asks what type of
pricing method can coordinate the two channels and whether the method is implementable for both channels.
We find that wholesale price cannot coordinate the supply chain, but that a price markup method can achieve
supply chain coordination and results in a win–win outcome.
This paper is organized into section. Section 2 describes the supply chain structure that we analyze and the
theoretical background of how we relate the analytical model to the consumer behavior theory. Section 3 dis-
cusses the pricing decision under both channel and brand competition, which is formulated as a Nash game
between the two channels. Section 4 provides various analyses of the behavior of the Nash prices. We also
propose several business implications. In Section 5, we assess how a supply chain pricing method can coordi-
nate the two channels. Section 6 concludes the paper.
2. Price competition system
2.1. Supply chain structure
Our paper considers a two-stage supply chain composed of two distribution channels: a national brand sup-
ply chain (NBSC) and a store brand supply chain (SBSC). The NBSC contains an NB manufacturer and
a direct store that the NB manufacturer runs directly. The SBSC contains a retail chain store and an SB
264 H. Kurata et al. / European Journal of Operational Research 180 (2007) 262–281
National brand supply chain (NBSC)
NB Direct Store p0
manufacturer
w1
Production cost: c1
Customers
Store brand supply chain (SBSC) p1
SB Retail Chain p2
manufacturer Store
Production cost: c2
Decision variables
: Flow of items For NBSC: Retail price p0,
For SBSC: Retail price p1,& p2
Fig. 1. Supply chain structure with NB vs. SB competition.
manufacturer that is controlled by the retail chain. We assume that the SB is sold only at the retail chain store
whereas the NB is available at both the direct store and the chain store. Notice that our supply chain structure
reflects an actual retail situation. For example, a Hewlett–Packard (HP) computer is sold at both its direct
channel (the HP online shop) and bricks-and-mortar computer stores (e.g., COMPUSA). Also, local computer
stores often sell original generic brand computers. In our framework, the decision variables are prices: an NB
manufacturer determines the retail price of the NB at its direct store whereas a chain store decides the retail
prices of both NBs and SBs. Fig. 1 shows our supply chain framework.
2.2. Customer choice perspectives
Brand choice. There are two types of decision processes in consumer decision-making: a decision made
before the consumer’s arrival at a store and a decision made inside the store (Bucklin and Lattin, 1991). Bett-
man (1979) explains that the first type of decision process is based on internal information: information that is
available in the consumer’s memory. The second type of decision process is based on external information,
which is acquired from outside sources, such as in-store display, the sales person’s explanation, actual contact
with the product, and so on.
In this paper, we assume that parameters b1 and b2 capture consumers’ brand choice behavior: b1 is the
intensity of the effect on brand choice of the first type of decision process (i.e., internal information-based
brand choice), and b2 is the intensity of the effect on brand choice of the second type (i.e., external informa-
tion-based brand choice). In our model, b1 is also understood as the cross-brand price sensitivity between an
NB sold at a direct channel and an SB sold at a chain store, and b2 is understood as the cross-brand price
sensitivity between an NB and an SB both sold at a chain store. According to Bawa and Shoemaker (1987)
and Ailawadi (2001), more out-of-store (more in-store) marketing activities lead to more frequent brand
switching, causing b1 (b2) to increase. Fig. 2 illustrates the concept of our parameter interpretation.
Store choice. This paper also addresses competition between channels. The parameter b0 captures the dif-
ference between the customers’ preference for the direct channel and the chain store channel. No physical dif-
ference usually exists between an NB sold at a direct store and an NB sold at a chain store. However, in a real
shopping environment, some customers prefer shopping via the Internet (e.g., Barnes & Noble’s web-store,
‘‘bn.com’’), whereas some customers prefer shopping at a traditional brick-and-mortar store (e.g., a regular
Barnes & Noble bookstore). In our model, b0 represents the cross-channel price sensitivity between an NB
sold at a direct store and an NB sold at a chain store. It is plausible to assume that b0 decreases as channel
loyalty increases. Fig. 2 illustrates b0 and its interpretation.
β 0 Channel choice
NBSC SBSC
NB sold at a
Difference chain store
between two
NBs
β0
NB at a Customers β 2 External
memory
direct store
β1
Original SB
Internal memory
: Interaction (correlation) between two brands

: Marketing actions influence consumer behavior (or interactions)
: Association between brand choice and channel choice
β0 represents correlation β1 is associated with a β2 is associated with a

between the two channels customer's choice customer's choice
and is associated with a between an NB and an SB between an NB and an SB
store choice and channel that is made by using that is made inside of a
loyalty. his/her memory. store.
Fig. 2. Customer’s decision processes and corresponding cross-price sensitivities.
SB positioning and parameter b. In addition to the interpretation that the bs come from decision processes
and store loyalty perspectives, an interpretation exists that involves relating b1 (or b2) to brand positioning.
Sayman et al. (2002) state that as an SB is positioned closer to the corresponding NB in the same category,
cross-price sensitivity increases. This means that b1 (or b2) should become larger as the SBSC repositions
its SB closer to the rival NB.
Interpretation of parameter b. In our model, the parameter b represents the self-price sensitivity. Note that
marketing literature explains that self-price sensitivity is negatively associated with the level of brand loyalty:
as loyalty for a particular brand increases, the brand becomes less price-sensitive.
3. Model
The following demand functions represent NB vs. SB competition:
The demand function for the NB at a direct store is
d 0 ¼ a 0 b 0 p 0 þ b0 p 1 þ b1 p 2 : ð1Þ
The demand function for the NB at a chain store is
d 1 ¼ a 1 b 1 p 1 þ b0 p 0 þ b2 p 2 : ð2Þ
The demand function for the SB is

d 2 ¼ a 2 b 2 p 2 þ b1 p 0 þ b 2 p 1 : ð3Þ
All notations are summarized in Table 1.
We have added some assumptions to the preceding demand functions:
Assumption 1. 0 < c1 < p0, c1 < w1 < p1, and 0 < c2 < p2.
Assumption 2. The magnitude of self-price sensitivity is greater than that of cross-price sensitivity: 0 6 bi < bj,
where i = 0, 1, or 2, and j = 0, 1, or 2.
Assumption 1 guarantees a firm’s participation in business. Assumption 2 is supported by empirical find-
ings that customers’ self-price sensitivity is stronger than their cross-price sensitivity. For instance, Hanssens
et al. (2001, Chapter 8) summarize a number of empirical findings regarding self- and cross-price sensitivity.
It is worth noting the reasons that our model uses a linear demand function. First, a linear function is trac-
table. Next, a linear demand function often achieves a satisfactory fit to the given data set (see Simon, 1989).
Third, we follow a tradition of microeconomics analysis (for example, Tirole, 1988; Wolfstetter, 1999) and
marketing research about brand management and pricing, such as Raju et al. (1995) and Sayman et al. (2002).
Profit functions. Based on the aforementioned demand functions, the profit functions under NB vs. SB com-
petition are formulated as follows:
The profit function for the NBSC is

p1 ¼ p1 ðp0 jp1 ; p2 Þ ¼ ðp0 c1 Þd 0 þ ðw1 c1 Þd 1 : ð4Þ
The profit function for the SBSC is
p2 ¼ p2 ðp1 ; p2 jp0 Þ ¼ ðp1 w1 Þd 1 þ ðp2 c2 Þd 2 : ð5Þ
Table 1
List of variables and parameters
pi Retail price of brand i
w1 Wholesale price of an NB
cj Production cost of the item in channel j
di Demand for brand i
ai Potential market size of brand i
bi Self-price sensitivity of brand i, where 0 < bi
b0 Cross-price sensitivity of an NB price at a direct store by an NB price at a chain store, 0 6 b0
b1 Cross-price sensitivity of an NB price at a direct store by an SB price, 0 6 b1
b2 Cross-price sensitivity of an NB price at a chain store by an SB price, 0 6 b2
pj Profit of channel j
pD Total profit at the Nash equilibrium prices for the disintegrated system
pi Nash solution price for brand i for the disintegrated system
pk1 NBSC’s profit from a direct channel sales (k = N), and from a chain store (k = S)
pk2 SBSC’s profit from NB sales (k = N), and from SB sale (k = S)
pI Total profit at optimal prices for the integrated system
p
i Optimal price for brand i for the integrated system
d
i Demand determined at the optimal prices, p
0 , p1 , and p2
pjl Profit allocated to channel j in the integrated system, p1I þ p2I ¼ pI
k0 Price markdown for the NB at a direct store
k1N NBSC’s price markup for the NB at a chain store
k1S SBSC’s price markdown for the NB at a chain store
k2 Price markdown for the SB
gi Difference in optimal prices between the disintegrated and integrated systems, gi ¼ pi p
i
Subscripts:
i = 0 for an NB at a direct store, i = 1 for an NB at a chain store, and i = 2 for an SB at a chain store
j = 1 for an NBSC and j = 2 for an SBSC
Notice that our model is deterministic: there is no error term that might capture uncontrollable shock coming
from outside the system. The profit functions above show expected profit in the long run for a stable market.
Nash pricing game. We assume a Nash game: both the NBSC and the SBSC simultaneously decide their
optimal prices so as to maximize profit. Note that this decision process reflects an actual situation in which
a chain store is a retail giant that can produce its own private brand and has managerial power over an
NB manufacturer. That is, the decision for each channel is
• the NB manufacturer determines the retail price p0, for the given p1 and p2;
• the chain store determines p1 and p2, for the given p0.
This Nash pricing game aims at profit maximization. The objective functions are formulated as follows:
The objective for the NBSC is

max p1 jp1 ; p2 ¼ ðp0 c1 Þd 0 þ ðw1 c1 Þd 1 : ð6Þ
p0
The objective for the SBSC is

max p2 jp0 ¼ ðp1 w1 Þd 1 þ ðp2 c2 Þd 2 : ð7Þ
p1 ;p2
Note that we assume that wholesale price, w1, is a parameter. This is because the wholesale price is usually
decided as a long-term contract between firms and does not often change, whereas it is common for stores to
frequently change their retail prices. In Section 5, we consider the effect of changes in wholesale price on sup-
ply chain performance as a supply chain contract issue.
Equilibrium prices. First, Property 1 shows the concavity of p1 (p2) with respect to p0 (p1 and p2) which guar-
antees the existence of the unique maximum point of the profit function.
Property 1 (Concavity of the profit functions).
(a) The NBSC profit function, p1, is concave in p0.

(b) The SBSC profit function, p2, is joint concave in p1 and p2.
Proof. Proof of Property 1, as well as the other remaining results, appears in Appendix. h
Solving the optimization models (6) and (7), we can determine the equilibrium prices: p0 for the NBSC and
p1 and p2 for the SBSC. See Lemma 1 for the equilibrium prices.

Lemma 1 (Nash equilibrium prices). The optimal2 retail
3 prices, p0 , p1 , and p2 , for2the given Nash game 3
between

p0 2b0 b0 b1
the two channels are determined as 4 p1 5 ¼ A1 B, where A 4 b0 2b1 2b2 5 and
2 3
a0 þ b0 c1 þ b0 ðw1 c1 Þ p2 b1 2b2 2b2
B4 a 1 þ b 1 w 1 b2 c 2 5:
a2 b2 w1 þ b2 c2
4. Analyses and marketing insights
4.1. Analysis of Nash equilibrium prices
In the actual retail business, stores often vary their marketing actions, such as advertising and promotions.
Such modifications then influence the parameter values of the demand function. Here we discuss the sensitivity
analysis of the equilibrium profit with respect to six parameters: b0, b1, b2, b0, b1, and b2, which represent var-
ious marketing decisions. We also examine the effect of wholesale price, w1. Property 2 summarizes the sen-
sitivities with respect to the equilibrium prices, and Theorems 1 and 2 show the sensitivities of the optimal
profit for each channel.
Property 2 (Sensitivity of the equilibrium prices). The sensitivity of the optimal prices with respect to the key
op op op
parameters are obtained as obij < 0, obi > 0, and owi1 > 0 for i = 0, 1, 2, and j = 0, 1, 2.
j
Theorem 1 (Analysis of sensitivity to the optimal profit of the NBSC). Set the profit from the direct store as
pN1 ¼ ðp0 c1 Þða0 b0 p0 þ b0 p1 þ b1 p2 Þ and the profit from the chain store as pS1 ¼ ðw1 c1 Þða1 b1 p1 þ
b0 p0 þ b2 p2 Þ,
opN opN
(a) 1
obi
< 0 and 1
obi
> 0 for i = 0, 1, and 2.
od 1 opS opS opS opS
(b) If obi
< 0, then 1
obi
< 0 and 1
obi
> 0; otherwise 1
obi
> 0 and 1
obi
< 0.
Theorem 2 (Analysis of sensitivity to the optimal profit of the SBSC). Set the profit from the NB sales as
pN2 ¼ ðp1 w1 Þða1 b1 p1 þ b0 p0 þ b2 p2 Þ and the profit from the SB sales as pS2 ¼ ðp2 c2 Þða2 b2 p2 þ
b1 p0 þ b2 p1 Þ.
opN opS opN opS
2
obi < 0, 2
obi < 0, 2
obi > 0, and 2
obi > 0 for i = 0, 1, and 2.
4.2. Verifying the model with close-to-reality data and discussions
In the previous section, we studied the behavior of the equilibrium profits for each channel with respect to
the self- and cross-price effect parameters and proposed several business implication. Here we graphically
60
58
b0
56 b1
54 b2
beta0
Profit
52 beta1
beta2
50
48
46
44
-10.0 -7.5 -5.0 -2.5 0.0 2.5 5.0 7.5 10.0
a parameter change (%)
21
20 b0
b1
19 b2
Profit
beta0
beta1
18 beta2
17
16
-10.0 -7.5 -5.0 -2.5 0.0 2.5 5.0 7.5 10.0
b parameter change (%)
Fig. 3. Numerical examples with close-to-reality data for NBSC (parameters: w1 = 5, c1 = 2, c2 = 4, b0 = 2.0, b1 = 3.0, b2 = 3.5, b0 = 0.4,
b1 = 0.2, b2 = 1.2, a0 = 20, a1 = 20, a2 = 20). Sensitivities of profit from (a) NB sales for NBSC and (b) SB sales for NBSC.
explain the change of the equilibrium by presenting several numerical examples to facilitate our analytical dis-
cussion. Note that our numerical examples include close-to-reality data. The plausibility of this approach can
be summarized as follows: First, we use comparative statics in our analysis: that is, equilibrium changes due to
a parameter value change, so that our focus is not to decide the exact parameter estimates but to understand
how equilibrium behaves when exposed to environmental change. Second, our examples assume a general rela-
tionship among parameters from the existing empirical analyses, such as how one parameter is greater than the
other. Thus, our examples demonstrate more generalized insight than when we use the data set of one certain
product.
We examine the effect of change of bi and bi for i = 0, 1, or 2. Our parameter setting is shown in the upper
part of Figs. 3 and 4. In numerical example development, we first collect information about the relationship
among parameter values from existing empirical studies (e.g., Hanssens et al., 2001; Pauwels and Srinivasan,
2004; Wedel and Zhang, 2004). For example, from existing estimation results we determine a reasonable ratio
of one parameter to another. Second, we calculate the change of the optimal profits with respect to self- and
cross-price effect parameters. In particular, we change each price effect parameter by either +10% or 10%.
In our numerical setting, the optimal profits are determined as p0 ¼ 7:35, p1 ¼ 8:68, and p2 ¼ 7:16. First,
Fig. 3(a) and (b) shows the sensitivities of the NBSC’s profit from sales at its direct channel and store channel,
respectively. In contrast, Fig. 4(a) and (b) illustrates how parameter change influences the profit from NB sales
and SB sales, respectively, at the SBSC. In these graphs, we show that self-price effects b’s have a negative
impact on profits, while the cross-price effect b’s have a positive impact. These effects are consistent with Say-
man and Raju (2004) conclusion.
25
b0
24 b1
23 b2
beta0
22
beta1
21
Profit
beta2
20
19
18
17
16
-10.0 -7.5 -5.0 -2.5 0.0 2.5 5.0 7.5 10.0
a parameter change (%)
24
b0
23 b1
b2
22 beta0
21 beta1
Profit
beta2
20
19
18
17
16
-10.0 -7.5 -5.0 -2.5 0.0 2.5 5.0 7.5 10.0
b parameter change (%)
Fig. 4. Numerical examples with close-to-reality data for SBSC (parameters: w1 = 5, c1 = 2, c2 = 4, b0 = 2.0, b1 = 3.0, b2 = 3.5, b0 = 0.4,
b1 = 0.2, b2 = 1.2, a0 = 20, a1 = 20, a2 = 20). Sensitivities of profit from (a) NB sales for SBSC and (b) SB sales for SBSC.
We derive several managerial implications from Theorems 1 and 2 and the numerical examples. First, an
SBSC manager should: (1) develop brand loyalty for both an NB and an SB, (2) not build up channel loyalty,
(3) employ marketing activities that target the customer’s internal memory and (4) employ marketing activities
that target the customer’s external memory. In contrast, an NBSC manager should use the same marketing
activities as an SBSC manager in order to increase profit from the direct channel, but should remember that
the marketing decisions of an NBSC are profitable for an NB sold at a chain store as long as they increase NB
sales at the chain store. Thus, Theorems 1 and 2 imply that reasonable marketing decisions are inconsistent
between the two channels; in particular, NBSC management should be careful when making marketing deci-
sions for NB sales at a chain store. This restriction for the NBSC results from the disintegrated decision pro-
cess in the system. Note that no such constraint for marketing decisions exists in the integrated system, which
we discuss in Section 5. Common shortcomings resulting from a disintegrated supply chain are order size
reduction (e.g., Spengler, 1950) and weakened motivation for the retailer (e.g., Krishnan et al., 2004). Theorem
2 shows another shortcoming resulting from a disintegrated system.
Second, Theorems 1 and 2 imply that channel loyalty is less important for the supply chains, whereas brand
loyalty is critical. This advice is consistent with an empirical conclusion by Bonfrer and Chintagunta that store
loyalty is negatively associated with brand loyalty, regardless of NB or SB (Bonfrer and Chintagunta, 2004).
This is also consistent with our advice about store loyalty and brand loyalty. We can conclude that the supply
chain benefits when there are intense interactions and customers switch between the NBSC and the SBSC.
Third, in the real retail business, the NBSC does not control SB brand loyalty and the SBSC does not care
about loyalty to the NB through the direct channel. However, Theorems 1 and 2 state that SB loyalty building
(NB loyalty building through the direct channel) is beneficial even for the NBSC (SBSC). This is caused by
spillovers (externality) in brand loyalty development. Also, the advantage of a multi-channel strategy is often
discussed (e.g., Chiang et al., 2003). Our second and third findings may offer additional evidence for the ten-
dency of a firm to establish its own direct store or original brand.
4.3. Marketing policies when a direct channel is completely segmented
As an extension of Section 4.1, this section considers a special supply chain case in which a direct channel is
completely segmented so that no interaction exists between the two channels (i.e., a case with b0 = b1 = 0).
This model setting is realistic because it is not uncommon for a firm to use a store channel for its local market
and a direct channel (e.g., an e-channel) for customers in remote areas (e.g., in foreign counties). When only
brand competition exists in the store channel, the preferable marketing strategies for the channels are obtained
as follows:
op1
Corollary 1 (Sensitivity of the optimal profit when there is brand competition only). For the NBSC, ob0 < 0,
op1 op1 op1
ob1 < 0, ob2 ¼ 0, and ob2 > 0.
op2 op2 op2 op2
For the SBSC, ob0 ¼ 0, ob1 < 0, ob2 < 0, and ob2 > 0.
One can interpret Corollary 1 as being profitable for the NBSC to develop NB loyalty for both direct and
store channels, focusing on marketing activities targeting external memory, but not to develop SB loyalty. On
the other hand, it is profitable for the SBSC to develop loyalty to the SB and loyalty to the NB sold through
the chain store, focusing on marketing activities targeting external memory, but not to develop loyalty for the
NB sold at a direct store.
Comparing Corollary 1 with Theorems 1 and 2, we see that appropriate marketing policies become more
simple and straightforward for each channel when there is brand competition only. For instance, in Corollary
1, the NBSC is not concerned with whether its marketing actions are increasing NB sales at the chain stores,
while the SBSC concentrates on sales at its chain stores. Hence, if brand competition is the only business issue,
it is reasonable for the NBSC to conduct mass media-based advertising (e.g., nationwide TV advertisements)
to boost loyalty to the NB, whereas the SBSC should conduct local advertising (e.g., in-store displays and
local newspaper advertisement) to appeal to customers’ external memory. Note that this implication is asso-
ciated with research conducted by Ailawadi et al. (2001) that shows brand loyal customers tend to purchase
national brands with out-of-store promotion.
4.4. Marketing policies when an SB is uniquely positioned
An SB often mimics the corresponding NB. For example, an SB often contains the same ingredients as an
NB and uses a similar name, packaging, and design (e.g., off-the-shelf drugs). However, another SB brand
strategy is to differentiate the SB from NBs in the same category by emphasizing its unique features and high
quality. A well-known example of such unique SB positioning is found with store brand cookies sold at a gro-
cery chain. This section considers the scenario when the SBSC sets unique product characteristics and a niche
strategy for its SB (i.e., the case with b1 = b2 = 0). With a unique SB strategy such as this, the optimal mar-
keting policies are determined as follows:
Corollary 2 (Sensitivity of the optimal profit when only channel competition exists). For the NBSC, always
op1 op op op
< 0, ob21 < 0; but ob11 < 0 and ob1 > 0 if
ob0 0
b0 ðp1 c1 Þ > b1 ðw1 c1 Þ; ð8Þ

op1 op1
otherwise, ob1
> 0 and ob0
< 0.
op2 op2 op2 op2
For the SBSC, always ob0 < 0, ob1 < 0, ob2 ¼ 0, and ob0 > 0.
The interpretation of Corollary 2 is that it is profitable for the SBSC to develop NB loyalty, but not prof-
itable to develop channel loyalty. Meanwhile, it is always advantageous for the NBSC to develop loyalty to the
NB through a direct channel. However, developing loyalty to the NB sold through a chain store is beneficial
for the NBSC only if b0 ðp1 c1 Þ > b1 ðw1 c1 Þ; otherwise, the NBSC should develop channel loyalty instead
of loyalty to the NB sold through the store.
Corollary 2 shows the asymmetric marketing policies of the two channels. Condition (8) can be understood
as ‘‘the NBSC’s increase in profit as a result of channel switching effect is greater than its drop in profit as a
result of self-pricing effect.’’ That is, Corollary 2 is rephrased as follows: if the NBSC can win more sales, it
should focus on brand management, but if it risks losing customers through its brand-oriented marketing
actions, the management focus should be on channel loyalty building.
Finally, Table 2 summarizes the preferred marketing decisions for both the NBSC and the SBSC with
respect to three cases: a general case in Section 4.1, a brand competition only case in Section 4.2, and a channel
competition only case in Section 4.3.
Table 2
Summary of sensitivities and recommended marketing decisions for the store brand supply chain (SBSC) and the national brand supply
chain (NBSC)
General case (both brand and Segmented direct channel case Unique SB case (only channel
channel competition) (only brand competition) competition)
NBSC SBSC NBSC SBSC NBSC SBSC
Preferable Preferable Preferable Preferable Preferable Preferable
direction of direction of direction of direction of direction of direction of
the parameter the parameter the parameter the parameter the parameter the parameter
change change change change change change
b0 Decreasea Decreaseb Decrease 0 Decrease Decreaseb Brand loyalty for an NB sold
by a direct channel
b1 Decreasea Decrease Decrease Decrease Decreasec Decrease Brand loyalty for an NB sold
at a chain store
b2 Decreasea,b Decrease 0 Decrease Decreaseb 0 Brand loyalty for an SB
b0 Increasea Increase – – Increasec Increase Channel/store loyalty
b1 Increasea Increase – – – – Customers’ internal memory.
Positioning of an SB
b2 Increasea Increase Increase Increase – – Customers’ external memory.
Positioning of an SB
a
Marketing actions should increase NB sales at a chain store.
b
The channel does not directly control this parameter.
c
NBSC profit should increase due to marketing actions.
5. Supply chain coordination
One of the main questions in supply chain research is whether supply chain contract can improve the per-
formance of the entire supply chain system, and if so, how. Note that the common approach in supply chain
coordination studies is to compare disintegrated and integrated systems. Tirole (1988, Chapter 4) summarizes
the vertical coordination of a manufacturer–retailer system under deterministic models and our discussion
owes much to his work. Here we define supply chain coordination as the maximizing of the total profit of
the system, including both the NBSC and the SBSC; a win–win outcome as both channels are better off as a
result of the coordination; and efficiency as the difference in the total profits between integrated and disinte-
grated systems. Note that the requirement for a win–win outcome plays an important role when the viability
of supply chain coordination is considered. Win–win outcomes exclude coordination in which efficiency is
improved by sacrificing one party’s profit (Taylor, 2001, 2002).
In an integrated supply chain system, all the organizations are unified and one decision maker optimizes the
performance of the total system as a global optimization problem. In our modeling framework, the optimal
prices for the integrated system can be obtained by maximizing the profit of the system, pI, with respect to
three retail prices:
max pI ¼ ðp0 c1 Þd 0 þ ðp1 c1 Þd 1 þ ðp2 c2 Þd 2 :

p0 ;p1 ;p2
Property 3 proves the existence of a unique optimal solution for the profit function, pI, and Lemma 2 shows
the equilibrium prices for the integrated system.
Property 3 (Concavity of the profit function of the integrated system). The profit function for the centralized
system, pI, is joint concave with respect to p0, p1, and p2.
Lemma 2 (Optimal prices for the integrated system). For the centralized system, optimal prices, p
0 , p1 , and

p2 , are obtained as
2 3
p0
6 7
4 p1 5 ¼ A01 B0 ;
p
2 2 3 2 3
2b0 2b0 2b1 a 0 þ b 0 c 1 b0 c 1 b1 c 2
where A0 4 2b0 2b1 2b2 5 and B0 4 a1 þ b1 c1 b0 c1 b2 c2 5.
2b1 2b2 2b2 a 2 þ b 2 c 2 b1 c 1 b2 c 2
From Lemma 2, the optimal total profit for the integrated system can be expressed as follows:

pI ¼ ðp
0 c1 Þd 0 þ ðp 1 c1 Þd 1 þ ðp 2 c2 Þd 2 :
On the other hand, the model in Section 4.1 is a disintegrated system, in which each channel makes its pricing
decision independently. The total profit for the disintegrated system, pD , is defined as
pD ¼ p1 þ p2 ¼ ðp0 c1 Þd 0 þ ðp1 c1 Þd 1 þ ðp2 c2 Þd 2 :
Property 4 summarizes the relationship between the two systems.
Property 4 (The integrated system vs. the disintegrated system).
(a) pI P pD .

(b) Generally, pi 6¼ p
i for i = 0, 1, 2.
(c) As pi deviates from p
i for i = 0, 1, 2, the difference between the maximum profit of the integrated system
and the disintegrated systems increases.
We know from Property 4 that the disintegrated system becomes more efficient if the equilibrium prices are
moved closer to those of the integrated system by adjusting p0 , p1 , and p2 . It is easy to show that either pi < p
i
or pi > p

i is possible for any i. Thus, as Property 2 suggests, marketing actions might change the optimal
prices in the long run, but do not guarantee the reduction of distance between pi and p
i . Therefore, we must
consider some mechanism for achieving coordination. We examine two supply chain coordination approaches
which are related to pricing decisions: wholesale price coordination and price markup coordination.
Wholesale price coordination. Our assumption so far is that wholesale price w1 is exogenous. However, sup-
ply chain coordination research often investigates the effect of a wholesale price change on supply chain effi-
ciency and the possibility of supply chain coordination (Tirole, 1988). Theorem 3 shows the result for our
model.
Theorem 3 (Wholesale value coordination). It is impossible to coordinate the two distribution channels by
manipulating the wholesale price w1, only. Even setting w1 = c1 does not coordinate the system.
Theorem 3 is interesting because, in a traditional one-item-and-one-channel supply chain, setting wholesale
price equivalent to unit production cost (i.e., w1 = c1) can result in the system coordination (Tirole, 1988,
Chapter 4). However, in our two-item-and-two-channel case, such a wholesale price adjustment does not
achieve coordination. This is an example of a negative effect of multiple products or channel supply chains
on system performance. In most cases, a firm has more than one product or channel. Thus, this discussion
suggests the difficulty of supply chain coordination.
Price markup coordination. The second coordination mechanism is to add (or subtract) some price markups
(or markdowns) for the three retail prices. We call this mechanism price markup coordination. Here, we con-
sider the four price markups: a price adjustment for the NB at a direct store (k0), a wholesale price markup
offered by the NBSC (k1N), a retail price discount for the NB at a chain store that is offered by the SBSC (k1S),
and a price adjustment for the SB (k2). Theorem 4 shows the result for the price markup contract.
Theorem 4 (Price markup coordination). There exist the price markup and markdown values, k 0 ; k 1N ; k 1S , and
k 2 , which can achieve p1D þ p2D ¼ pI and p1D P p1 and p2D P p2 , where p1D and p2D are the profit under price
markup coordination for the NBSC and SBSC, respectively.
The meaning of Theorem 4 is twofold: the price markup approach can coordinate the system and also
accomplish a win–win scenario. That is, by skillfully adjusting markup prices, each channel can simulta-
neously increase its profit and improve coordination. Also, no fixed cost is required in our model to achieve
250000
200000
Profit ($)
150000
100000
50000
10 20 30 40 50 60 70 80 90 100
Wholesale price (w1)
Total Profit of Disintegrated System Total Profit of Integrated System
NBSC's Profit of Disintegrated System SBSC's Profit of Disintegrated System
Fig. 5. Effect of wholesale price (w1) on the profits for the integrated and disintegrated systems (parameters: a0 = a1 = a2 = 1000,
b0 = b1 = 5, b2 = 7, b0 = b1 = b2 = 1, and c1 = c2 = 10).
Table 3
The example of price markup coordination
Disintegrated system
Equilibrium prices p0 ¼ $140:0
p1 ¼ $173:5
p2 ¼ $105:6
Maximum profits p1 ¼ $101; 744:2
p2 ¼ $90; 249:9
Total profit pD ¼ $191; 944:0
Integrated system
Equilibrium prices p
0 ¼ $158:8
p
1 ¼ $158:8
p
2 ¼ $120:4
Total profit pI ¼ $196; 813:4
Disintegrated system with price markup coordination
Equilibrium prices p0 þ k 0 ¼ $158:8 Markups k 0 ¼ $18:8
p1 þ k 1N k 1S ¼ $158:8 k 1N ¼ $ 2:0

p
2 þ k 2 ¼ $120:4 k 1S ¼ $12:7
Maximum profits p1D ¼ $105; 191:4 ð> p1 Þ k 2 ¼ $14:8
p2D ¼ $91; 622:1 ð> p2 Þ
Total profit p1D þ p2D ¼ $196; 813:4 ð¼ pI Þ
Parameters: a0 = a1 = a2 = 1000, b0 = b1 = 5, b2 = 7, b0 = b1 = b2 = 1, w1 = 80, and c1 = c2 = 10.
coordination, whereas a fixed cost (e.g., franchise fee) is necessary to achieve coordination in a traditional one-
product one-channel system (e.g., Tirole, 1988, Chapter 4). One managerial implication of Theorem 4 is that
possessing one’s own distribution channel (one’s own brand) is strategically beneficial for the NBSC (the
SBSC) since coordination of the system is guaranteed. Theorem 4 also shows that firms tend to establish
its own e-channel or original brand.
We next show numerical examples. Using arbitrary parameter values, Fig. 5 shows the effect of wholesale
price, w1, on total profits. As w1 increases, the profit of the disintegrated system first increases but then
decreases without reaching the level of the integrated system. Using the same parameter values and fixing
the wholesale price at $80, Table 3 presents one example of markup/markdown price combinations
(k 0 ¼ 18:8, k 1N ¼ 2:0, k 1S ¼ 12:4, and k 2 ¼ 14:8) that can achieve both system coordination and a win–
win outcome.
6. Concluding remarks
Our research investigates the optimal pricing decision for a two-stage supply chain when a national brand
(NB) and a store brand (SB) compete with each other using two distribution channels, a direct channel and a
store channel. A Nash pricing game determines the equilibrium prices for the two channels. We then connect
the sensitivity result of the equilibrium prices with existing consumer behavior theory and propose several
business implications for retail management. We find that marketing decisions by an NB manufacture are
more restrictive than those by a chain store, and that brand loyalty development is more important than chan-
nel loyalty development. Additionally, we study two special cases: a case in which an SB is uniquely positioned
and only channel competition exists, and a case in which a direct channel is uniquely positioned and only
brand competition exists. Our analysis suggests that the target of marketing activities can be more clearly
and narrowly determined if management uses a direct channel or a uniquely positioned SB. Table 2 lists
the appropriate marketing policies for each channel.
Next, we analyze channel coordination regarding pricing decisions. We assess wholesale price coordination
and price markup coordination. Our finding is that wholesale price adjustment does not coordinate the supply
chain, but price markup coordination can achieve both supply chain coordination (i.e., a decentralized system
can attain the profit of the centralized system) and a win–win outcome (i.e., each channel is better off as a
result of the contract). The existence of a win–win outcome is critical for supply chain coordination implemen-
tation because it guarantees an incentive for each channel to accept the method.
There are several unanswered but important questions in this paper. First, our model discusses only price
competition in its analysis of multi-channel management under NB vs. SB competition. It would be interesting
to add other marketing actions, such as advertising, into the model as decision variables. Second, our model is
deterministic, and we mainly analyze cross-channel and cross-brand competition from the point of view of
marketing. Future research should apply a stochastic model and inspect supply chain performance from dif-
ferent managerial points, such as stock level competition or supply chain contract for the stochastic model, for
example a buyback policy. Third, this is an analytical study. Although it is very difficult to obtain a proper
data set, if possible, an empirical study should be carried out to confirm the plausibility of our model frame-
work and the findings from the analytical results.
Appendix
od 0
Proof of Property 1. (a) From (1), (2), and (4), the first-order condition (FOC): op op0 ¼ d 0 þ ðp 0 c1 Þ op0 þ
1
od 1 o 2 p1 od 0
ðw1 c1 Þ op ¼ d 0 þ ðp0 c1 Þðb0 Þ þ ðw1 c1 Þb0 . Thus, the second-order condition (SOC): op2 ¼ op b0 ¼
0 0 0
2b0 < 0.
op2
From (2), (3), and (5), FOCs: op1 ¼ d 1 þ ðp1 w1 Þ od 1 od 2
op þ ðp 2 c2 Þ op ¼ d 1 þ ðp 1 w1 Þðb1 Þ þ ðp2 c2 Þb2 .
1 1
op2
op2 ¼ ðp1 w1 Þ od
op þ d 2 þ ðp 2
1
c2 Þ od
op2
2
¼ ðp1 w1 Þb2 þ d 2 þ ðp2 c2 Þðb2 Þ.
2
o 2 p2 2 2
SOCs: ¼ od
op21
1 o p2 od 1 o p2 od 1
op1 b1 ¼ 2b1 < 0. op22 ¼ op2 b2 ¼ 2b2 < 0. op1 op2 ¼ op2 þ b2 ¼ 2b2 > 0.

2b1 2b2
Let H be a Hessian of p2 : H ¼ . At this time, detðH Þ ¼ 4ðb1 b2 b22 Þ.
2b2 2b2
Under Assumption 2, the Hessian matrix H is a negative definite because H11 = 2b1 < 0, and
detðH Þ ¼ 4ðb1 b2 b22 Þ > 0. Hence, p2 is joint concave in p1 and p2. h
Proof of Lemma 1. The Nash solution can be determined by simultaneously solving the following system of
the three first-order conditions:
op1
¼ d 0 þ ðp0 c1 Þðb0 Þ þ ðw1 c1 Þb0
op0
¼ 2b0 p0 þ b0 p1 þ b1 p2 þ a0 þ b0 c1 þ b0 ðw1 c1 Þ; ðA:1Þ
op2
¼ d 1 þ ðp1 w1 Þðb1 Þ þ ðp2 c2 Þb2
op1
¼ b0 p0 2b1 p1 þ 2b2 p2 þ a1 þ b1 w1 b2 c2 ; ðA:2Þ
op2
¼ ðp1 w1 Þb2 þ d 2 þ ðp2 c2 Þðb2 Þ
op2
¼ b1 p0 þ 2b2 p1 2b2 p2 þ a2 b2 w1 þ b2 c2 : ðA:3Þ
We can rewrite (A.1)–(A.3) as a following matrix form:

2 32 3 2 3
2b0 b0 b1 p0 a0 þ b0 c1 þ b0 ðw1 c1 Þ
6 76 7 6 7
4 b0 2b1 2b2 54 p1 5 ¼ 4 a1 þ b1 w1 b2 c2 5:
b1 2b2 2b2 p2 a2 b2 w1 þ b2 c2
2 3 2 3 2 3
2b0 b0 b1 p0 a0 þ b0 c1 þ b0 ðw1 c1 Þ
Set A 4 b0 2b1 2b2 5, P 4 p1 5, and B 4 a 1 þ b 1 w 1 b2 c 2 5.
b1 2b2 2b2 p2 a 2 b2 w 1 þ b 2 c 2
Note that from Assumption 2, a matrix A is strictly diagonally dominant. All the diagonal entries in A are
positive. Hence, a matrix algebra fact shows that A is nonsingular and positive definite. As a result, the
optimal prices can be determined as
t
½ p0 p1 p ¼ A1 B: ðA:4Þ
Finally, we summarize (A.4) as the Nash solution of the given game. h
Proof of Property 2. Our proof follows a common comparative statics method. Substitute p0 , p1 , and p2 into
(A.1)–(A.3):
2b0 p0 b0 p1 b1 p2 ¼ a0 þ b0 c1 þ b0 ðw1 c1 Þ; ðA:5Þ

b0 p0 þ 2b1 p1 2b2 p2 ¼ a1 þ b1 w1 b2 c2 ; ðA:6Þ
b1 p0 2b2 p1 þ 2b2 p2 ¼ a 2 b2 w 1 þ b 2 c 2 : ðA:7Þ
Taking the derivative of (A.5)–(A.7) with respect to b0, we obtain

o o o
2b0 p 0 b0 p 1 b1 p ¼ c1 2p0 ; ðA:8Þ
ob0 ob0 ob0 2
o o o
b0 p þ 2b1 p 2b2 p ¼ 0; ðA:9Þ
ob0 0 ob0 1 ob0 2
o o o
b1 p0 2b2 p1 þ 2b2 p ¼ 0: ðA:10Þ
ob0 ob0 ob0 2
(A.8)–(A.10) can be expressed by a matrix form as follows:
2 3 2 3
op0 =ob0 c1 2p0
6 7 6 7
A 4 op1 =ob0 5 ¼ 4 0 5: ðA:11Þ

op2 =ob0 0
Applying Cramer’s rule to (A.11), op0 =ob0 can be defined as follows:

2 3

c1 2p0 b0 b1
op0 1 6 7
¼ det 4 0 2b1 2b2 5: ðA:12Þ
ob0 detðAÞ
0 2b2 2b2
The denominator of (A.12), det(A), is positive because A is a positive definite matrix. In such case, the sign of
op0 =ob0 is determined by the sign of
2 3
c1 2p0 b0 b1
6 7
det 4 0 2b1 2b2 5:
0 2b2 2b2
Here,
2 3
c1 2p0 b0 b1
6 7
det 4 0 2b1 2b2 5 ¼ ðc1 2p0 Þð4b1 b2 4b22 Þ:
0 2b2 2b2
op0
From Assumptions 1 and 2, the determinant value is always negative. Consequently, we obtain ob0
< 0. Use
the same logic to p1 and p2 :
2 3 2 3
2b0 c1 2p0 b1 2b0 c1 2p0 b1

op1 1 6 7 6 7
¼ det 4 b0 0 2b2 5 and det 4 b0 0 2b2 5
ob0 detðAÞ
b1 0 2b2 b1 0 2b2
¼ ð1Þðc1 2p0 Þð2b0 b2 2b1 b2 Þ ¼ ðc1 2p0 Þð2b0 b2 þ 2b1 b2 Þ < 0:
Also,
2 3 2 3
2b0 b0 c1 2p0 2b0 b0 c1 2p0
op2 1
¼ det 4 b0 2b1 0 5 and det 4 b0 2b1 0 5
ob0 detðAÞ
b1 2b2 0 b1 2b2 0
¼ ðc1 2p0 Þð2b0 b2 þ 2b1 b1 Þ < 0:
op op
As a result, ob10 < 0 and ob20 < 0. Applying the same logic for the sensitivity of the optimal prices with respect to
b1, b2, b0, b1, b2, and w1, we also obtain the remaining results Property 2. h
Proof of Theorems 1 and 2. We apply an envelop theorem: the derivative of the optimal value with respect to
the parameter is equivalent to the partial derivative of the objective
function when the derivative is evaluated
op1 op1 op
by the optimal solution (Varian, 1992). For example, ob0 ¼ ob0 . As for ob01 , p1 is a function of p0, but p1
p0 ;p1 ;p2
and p2 are implicitly influenced by b0. Thus, the derivative of p1 with respect to b0 is

op1 op op op op
¼ ðp0 c1 Þ p0 þ b0 1 þ b1 2 þ ðw1 c1 Þ b1 1 þ b2 2 : ðA:13Þ
ob0 ob0 ob0 ob0 ob0
op op
From Property 2, ob10 < 0 and ob20 < 0 at the optimal point. Therefore, the first term of (A.13) is always negative.
opN od
Hence, 1
ob0
< 0. The inside of {} in the second term is od
ob0
1
. Thus, the second term is negative if ob01 < 0. Applying
the same logic to the other parameters and p2, we can prove all of Theorems 1 and 2. h
Proof of Corollary 1. If b0 = b1 = 0, then we can simplify the profit functions as follows:

p1 ¼ ðp0 c1 Þða0 b0 p0 Þ þ ðw1 c1 Þða1 b1 p1 þ b2 p2 Þ
and
p2 ¼ ðp1 w1 Þða1 b1 p1 þ b2 p2 Þ þ ðp2 c2 Þða2 b2 p2 þ b2 p1 Þ:
Using the same logic as Theorems 1 and 2, we determine the derivative of the optimal profit with respect to b1 as

op1 op1 op1 op2
¼ ¼ ðw1 c1 Þ p1 b1 þ b2 ;
ob1 ob1 p ;p ;p ob1 ob1
0 1 2
ðA:14Þ
op2 op2
¼ ¼ ðp1 w1 Þðp1 Þ:
ob1 ob1 p ;p ;p
0 1 2
If b0 = b1 = 0, (A.5)–(A.7) can be modified as follows:

2 32 3 2 3
2b0 0 0 p0 a0 þ b0 c 1
6 76 7 6 7
4 0 2b1 2b2 54 p1 5 ¼ 4 a1 þ b1 w1 b2 c2 5: ðA:15Þ
0 2b2 2b2 p2 a2 b2 w1 þ b2 c2
2 3
2b0 0 0
e4 0
Set A 2b1 e ¼ 8b0 ðb1 b2 b2 Þ > 0. Using the same approach as Property
2b2 5. Note that detð AÞ 2
0 2b2 2b2
2, we obtain
2 3
2b0 0 0
op1 1 6 7 4b0 b2 ðw1 2p1 Þ

¼ 4 0 w1 2p1 2b2 5 ¼ < 0;
ob1 e
detð AÞ e
detð AÞ
0 0 2b2
and
2 3
2b0 0 0
op2 1 6

7 4b0 b2 ðw1 2p1 Þ
¼ 4 0 2b1 w1 2p1 5 ¼ < 0:
ob1 e
detð AÞ e
detð AÞ
0 2b2 0
op op 4b0 b1 b2 ðw1 2p1 Þ 4b0 b22 ðw1 2p1 Þ 4b0 ðb22 b1 b2 Þðw1 2p1 Þ
At this time, b1 ob11 þ b2 ob21 ¼ þ ¼ . By solving (A.15),
detðe
AÞ detðe
AÞ detðe
AÞ
4ðb1 b2 b22 Þða0 þb0 c1 Þ op1 op2 4ðb22 b1 b2 Þða0 þb0 c1 Þ 4b0 ðb22 b1 b2 Þðw1 2p1 Þ 4ðb22 b1 b2 Þða0 2b0 p1 þb0 ðc1 þw1 ÞÞ
p1 ¼ . Thus, p1 b1 ob1 þ b2 ob1 ¼ þ ¼ .
detðe
AÞ detðe
AÞ detðe
AÞ detðe
AÞ
A linear demand model commonly assumes that a0 is large enough so that a0 2b0 p1 þ b0 ðc1 þ w1 Þ is positive.
op1 op
Thus, we finally conclude ob1 < 0. Also obviously, ob12 < 0. Using the same logic to the remaining parameters,
op1 op1 op1 op2 op2 op
we determine ob0 < 0, ob2 ¼ 0, ob2 > 0, ob0 ¼ 0, ob2 < 0, and ob22 > 0. h
Proof of Corollary 2. If b1 = b2 = 0, then we can simplify the profit functions as follows:
p1 ¼ ðp0 c1 Þða0 b0 p0 þ b0 p1 Þ þ ðw1 c1 Þða1 b1 p1 þ b0 p0 Þ;
and
p2 ¼ ðp1 w1 Þða1 b1 p1 þ b0 p0 Þ þ ðp2 c2 Þða2 b2 p2 Þ:
Using the same logic as Theorems 1 and 2, we determine the derivative of the maximum profit with respect to
the parameters as follows:

op1 op1 op1
¼ ðp0 c1 Þ p0 þ b0 þ ðw1 c1 Þ b1 ; ðA:16Þ
ob0 p ;p ;p ob0 ob0
0 1 2

op2 op0
¼ ðp1 w1 Þ b0 : ðA:17Þ
ob0 p ;p ;p ob0
0 1 2
If b1 = b2 = 0, (A.5)–(A.7) can be modified as follows:

2 32 3 2 3
2b0 b 0 p0 a0 þ b0 c1 þ b0 ðw1 c1 Þ
6 76 7 6 7
6 b 2b1 0 76 p 7 ¼ 6 a1 þ b1 w1 7: ðA:18Þ
4 54 1 5 4 5

0 0 2b2 p2 a2 þ b2 c 2
2 3
2b0 b 0
Here, set A 4 b 2b1 0 5 in (A.18). Using the same approach as Property 2, we obtain:
0 0 2b2
For b0,
op0 4b1 b2 ðc1 2p0 Þ op1 4b0 b2 ðc1 2p0 Þ op2
¼ < 0; ¼ < 0; and ¼ 0:
ob0 detðAÞ ob0 detðAÞ ob0
For b1,
op0 2b0 b2 ðw1 2p1 Þ op1 4b1 b2 ðw1 2p1 Þ op2
¼ < 0; ¼ < 0; and ¼ 0:
For b2,
op0 op1 op2 ðc1 2p2 Þð4b0 b1 b20 Þ

¼ 0; ¼ 0; and ¼ < 0:
ob2 ob2 ob2 detðAÞ
For b0,
op0 2b2 ð2b1 ðp1 þ w1 c1 Þ þ b0 p0 Þ op1 2b2 ð2b0 ðp1 þ w1 c1 Þ þ b0 p0 Þ op2
¼ > 0; ¼ > 0; and ¼ 0:
op
Applying the derivatives of the optimal prices above to (A.16) and (A.17), we determine that always ob01 < 0,
op1 op op op op
ob2
< 0, ob02 < 0, ob12 < 0, ob22 ¼ 0, and ob20 > 0.
However, the signs are inconclusive for the following two derivatives:

op1 op1 op1
¼ ðp0 c1 Þ b0 þ ðw1 c1 Þ p1 b1 ; ðA:19Þ
ob1 p ;p ;p ob1 ob1
0 1 2

op1 op1 op1
¼ ðp c Þ p þ b þ ðw c Þ b þ p 0 : ðA:20Þ
ob0 p ;p ;p 0 1 1 0 1 1 1
ob0 ob0
0 1 2
op
From Property 3, ob11 < 0. Hence, we know that from (A.19), if (8) is satisfied (i.e., if b0 ðp1 c1 Þ > b1 ðw1 c1 Þ),
op1 op
then, ob1 < 0. Also, if the condition (8) is satisfied, from (A.20), ob10 > 0. h
Proof of Property 3 and Lemma 2. Apply the same logic as Lemma 1. Taking the derivatives of pI with respect
to p0, p1, and p2, we obtain
2 32 3 2 3
2b0 2b0 2b1 p0 a0 þ b0 c1 b0 c1 b1 c2
6 76 7 6 7
6 2b0 2b1 2b2 76 p1 7 ¼ 6 a1 þ b1 c1 b0 c1 b2 c2 7:
4 54 5 4 5
2b1 2b2 2b2 p2 a2 þ b2 c2 b1 c1 b2 c2
2 3 2 3
2b0 2b0 2b1 a0 þ b0 c1 b0 c1 b1 c2
Set A0 4 2b0 2b1 2b2 5 and B0 4 a1 þ b1 c1 b0 c1 b2 c2 5.
2b1 2b2 2b2 a2 þ b2 c2 b1 c1 b2 c2
A matrix A 0 is diagonally dominant and all the diagonal entries are positive. Thus, A 0 is non-singular and
positive definite. Consequently, the original pI is concave with respect to p0, p1, and p2, and the optimal price is
0
uniquely defined by A 1B 0 . h
Proof of Property 4. (a) Obvious from the foundations of optimization theory.

0
1 1
(b) Assume pi ¼ pi for i = 0, 1, and 2. If so, A B = A B 0 , where
2 3 2 3
4ðb1 b2 b22 Þ 2ðb0 b2 þ b1 b2 Þ 2ðb0 b2 þ b1 b1 Þ a0 þ b0 c1 þ b0 ðw1 c0 Þ
1 6 6 2ðb b2 þ b b Þ
7 6 7
A1 ¼ 4b0 b2 b21 4b0 b2 þ b0 b1 7 5; B ¼ 4 a1 þ b1 w1 b2 c2 5;
detðAÞ 4 0 1 2
2
2ðb0 b2 þ b1 b1 Þ 4b0 b2 þ b0 b1 4b0 b1 b0 a2 b2 w1 þ b2 c2
2 3 2 3
4ðb1 b2 b22 Þ 4ðb0 b2 þ b1 b2 Þ 4ðb0 b2 þ b1 b1 Þ a 0 þ b 0 c 1 b0 c 1 b 1 c 2
1 6 6
7 6 7
A01 ¼ 0 4 4ðb0 b2 þ b1 b2 Þ 4ðb0 b2 b21 Þ 4ðb0 b2 þ b0 b1 Þ 7 0
5; and B 4 a1 þ b1 c1 b0 c1 b2 c2 5:
detðA Þ
4ðb0 b2 þ b1 b1 Þ 4ðb0 b2 þ b0 b1 Þ 4ðb0 b1 b20 Þ a 2 þ b 2 c 2 b1 c 1 b 2 c 2
0
However, it is obvious that A1B = A 1B 0 is not always guaranteed. Thus, pi 6¼ p
i . (c) From the concavity of
the total profit function, pI, as pi deviated more from p
i , pD becomes much smaller than pI. h
Proof of Theorem 3. The maximum total profit for the disintegrated system, pD , is obtained as
pD ¼ p1 þ p2 ¼ ðp0 c1 Þd 0 þ ðp1 c1 Þd 1 þ ðp2 c2 Þd 2 : ðA:21Þ
(A.21) is the same structure as pI. From Lemma 2 and Theorem 3, pI is strictly concave with respect to the
three prices and maximized uniquely at p
0 , p 1 , and p 2 . It is easy to know that a vector
t
½ g0 g1 g2 ¼ A1 B A01 B0 is a system of three linear functions with respect to w1. Obviously, the three
functions are linearly independent so that there is no w1 that satisfies gi = 0 for all i’s. Consequently, it is
impossible that adjusting w1 achieves p0 ¼2p
0 , p 1 ¼ p 1 , and

3 p2 ¼ p2 . Thus, even if w1 changes, always
a0 þ b0 c 1
0
pD < p . In addition, if w1 = c 1 , then B 4 a 1 þ b1 c1 b2 c2 5. However, obviously A1B 5 A 1B 0 even if
I
a 2 þ b 2 c 2 b2 c 1
w1 = c1. Hence, setting w1 = c1 does not guarantee the system coordination. h
Proof of Theorem 4. We set four markup values that are equivalent to the difference between the two optimal
prices as follows:
2 3 23 2 3
k0 p
0 p0
6 7 6 7 6 7
4 1N
k k 1S 5 p
4 1 5 4 p 1 5: ðA:22Þ
k2 p
2 p2
The difference of the total profit between with and without markup contract for each channel is defined as
follows:

p1D p1 ¼ ðp

0 c1 Þd 0 þ ðw1 c1 þ k 1N Þd 1 ðp0 c1 Þd 0 þ ðw1 c1 Þd 1 ; ðA:23Þ

p2D p2 ¼ ðp

1 w1 k 1N Þd 1 þ ðp 2 c2 Þd 2 ðp1 w1 Þd 1 þ ðp2 c2 Þd 2 : ðA:24Þ
Clearly, (A.23) linearly increases in k1N, but (A.24) linearly decreases in k1N. Note that p1D þ p2D P p1 þ p2 .
Thus, there exists such k1N that satisfies p1D p1 > 0 and p2D p2 > 0.
For the given k1N, one can determine k1S from the equation p
1 ¼ p 1 þ k 1N k 1S . Such k1N and k1S are
optimal markup prices. Also, the remaining optimal markup prices, k 0 and k 2 , can be determined by (A.22).

Consequently, we show that there exist the four markups that can achieve both efficiency improvement and a
win–win outcome. h
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22-Pricing Poliies Under Direct vs. Indirect Channel Competition and National vs. Store Brand Competition

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European Journal of Operational Research 180 (2007) 262–281

Production, Manufacturing and Logistics

Pricing policies under direct vs. indirect channel competition

Received 10 March 2005; accepted 3 April 2006

2. Price competition system

2.1. Supply chain structure

National brand supply chain (NBSC)

Fig. 1. Supply chain structure with NB vs. SB competition.

2.2. Customer choice perspectives

: Interaction (correlation) between two brands

β0 represents correlation β1 is associated with a β2 is associated with a

Fig. 2. Customer’s decision processes and corresponding cross-price sensitivities.

The following demand functions represent NB vs. SB competition:

The demand function for the NB at a direct store is

The demand function for the NB at a chain store is

The demand function for the SB is

The proﬁt function for the NBSC is

The objective for the NBSC is

The objective for the SBSC is

(a) The NBSC profit function, p1, is concave in p0.

4. Analyses and marketing insights

4.1. Analysis of Nash equilibrium prices

4.2. Verifying the model with close-to-reality data and discussions

4.3. Marketing policies when a direct channel is completely segmented

4.4. Marketing policies when an SB is uniquely positioned

b0 ðp1 c1 Þ > b1 ðw1 c1 Þ; ð8Þ

5. Supply chain coordination

max pI ¼ ðp0 c1 Þd 0 þ ðp1 c1 Þd 1 þ ðp2 c2 Þd 2 :

(a) pI P pD .

or pi > p

We can rewrite (A.1)–(A.3) as a following matrix form:

2b0 p0 b0 p1 b1 p2 ¼ a0 þ b0 c1 þ b0 ðw1 c1 Þ; ðA:5Þ

Taking the derivative of (A.5)–(A.7) with respect to b0, we obtain

Applying Cramer’s rule to (A.11), op0 =ob0 can be deﬁned as follows:

Proof of Corollary 1. If b0 = b1 = 0, then we can simplify the proﬁt functions as follows:

If b0 = b1 = 0, (A.5)–(A.7) can be modiﬁed as follows:

Proof of Corollary 2. If b1 = b2 = 0, then we can simplify the proﬁt functions as follows:

p1 ¼ ðp0 c1 Þða0 b0 p0 þ b0 p1 Þ þ ðw1 c1 Þða1 b1 p1 þ b0 p0 Þ;

p2 ¼ ðp1 w1 Þða1 b1 p1 þ b0 p0 Þ þ ðp2 c2 Þða2 b2 p2 Þ:

If b1 = b2 = 0, (A.5)–(A.7) can be modiﬁed as follows:

op0 op1 op2 ðc1 2p2 Þð4b0 b1 b20 Þ

Proof of Property 4. (a) Obvious from the foundations of optimization theory.

pD ¼ p1 þ p2 ¼ ðp0 c1 Þd 0 þ ðp1 c1 Þd 1 þ ðp2 c2 Þd 2 : ðA:21Þ

p1D p1 ¼ ðp

p2D p2 ¼ ðp

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