Operations Research Letters 46 (2018) 373–378

Contents lists available at ScienceDirect

Operations Research Letters

journal homepage: www.elsevier.com/locate/orl

Resale price maintenance in supply chains with general multiplicative

demand
George J. Kyparisis *, Christos Koulamas
Department of Information Systems and Business Analytics, Florida International University, Miami, FL 33199, USA

article info a b s t r a c t
Article history: We analyze a supply chain with a Resale Price Maintenance (RPM) contract in which the manufacturer sets
Received 25 February 2018 the retail price with a general multiplicative price–demand function and prove the existence/uniqueness
Received in revised form 27 March 2018 of an equilibrium. We also compare the equilibrium prices and quantities, consumer surplus and total
Accepted 12 April 2018
system welfare for the RPM and wholesale price contracts. We conclude that a manufacturer may capture
Available online 30 April 2018
a smaller share of the total supply chain profit despite her ability to set the retail price.
© 2018 Elsevier B.V. All rights reserved.
Keywords:
Supply chain
Newsvendor
Price-dependent demand
Resale price maintenance
Consumer surplus

1. Introduction
In most supply chains with price-dependent demand, the retail
price is set by the retailer. Under an alternative arrangement,
called Resale Price Maintenance (RPM), a specified retail price
or a minimum advertised price is set by the manufacturer. The
vast majority of papers analyzing RPM contracts have appeared
in the economics literature with very few papers appearing in
the operations management and supply chain literature. According
to [7], the economics literature is primarily focused on explaining
observed contracts (such as RPM contracts) while the operations
management and supply chain literature are primarily concerned
with determining the optimal inventory levels and other related
quantities in multistage supply chains.
An RPM contract does not maximize the total supply chain
profit. Krishnan and Winter [7] showed that the total supply chain
profit can be maximized with a two-part tariff contract. Rey and
Tirole [12] and subsequently Rey and Verge [13] showed that un-
der uncertain demand, the manufacturer prefers an RPM contract
compared to either a two-part tariff contract or a wholesale price
contract. Rey and Tirole [12] and subsequently Elzinga and Mills [5]
showed that the consumer surplus and/or the total system welfare
may be higher with an RPM contract compared to either a two-part
tariff contract or a wholesale price contract. For these reasons, RPM
contracts have been analyzed in the literature (e.g. [10]). In this
paper, we present additional results for the consumer surplus of
* Corresponding author.
E-mail addresses: kyparis@fiu.edu (G.J. Kyparisis), koulamas@fiu.edu
(C. Koulamas).
an RPM contract and extend the results of [10] for the equilibrium
prices, quantities and profits to RPM contracts with more general
price–demand functions.
We consider a single retailer, single manufacturer supply chain
with an RPM setup similar to the one studied in [10]. In one of
their models, it was assumed that the retailer determines the order
quantity and the manufacturer determines both the wholesale
price and the retail price, with the retail price computed by adding
a fixed markup (to be optimized) to the wholesale price. This type
of RPM policy was called a Retail Fixed Markup (RFM) policy. Fol-
lowing the framework for the single-stage price-setting newsven-
dor problem in [11], Liu et al. [10] considered both multiplicative
isoelastic demand and additive linear demand. They proved the
existence/uniqueness of equilibrium retail and wholesale prices
and equilibrium order quantity for the problem with multiplica-
tive isoelastic demand. They also proved existence/uniqueness of
equilibrium retail price and equilibrium order quantity for the sim-
pler problem with a given fixed price markup and additive linear
demand. Furthermore, they compared the equilibrium quantities
and profits for the exact price RPM and wholesale price contracts.
A related paper [9] studied a supply chain with an RFM policy
and additive linear demand. Gurnani and Xu [6] also studied RPM
contracts with quantity fixing, price and quantity flexibility and
sales effort.
The objective of this paper is to extend the analysis in [10] to
supply chains with an exact price RPM contract with general mul-
tiplicative demand. Under mild assumptions on the deterministic
price–demand function, we prove existence/uniqueness of equi-
librium retail and wholesale prices and equilibrium order quantity
with general multiplicative demand. Our analysis can be used to

https://doi.org/10.1016/j.orl.2018.04.005
0167-6377/© 2018 Elsevier B.V. All rights reserved.
374 G.J. Kyparisis, C. Koulamas / Operations Research Letters 46 (2018) 373–378

test the robustness of the results in [10] by checking whether they w = pF̄ (z(w, p)) and G(z) = S(z) − F̄ (z)z, the optimal retailer profit
extend to price–demand functions other than the isoelastic. We list at z(w, p) is Πr (z(w, p)) = d(p)pG(z(w, p)).
some of these functions in the sequel. We compare the equilibrium Given z(w, p), the manufacturer’s profit maximization problem
quantities and profits, the consumer surplus and the total system is
welfare for the exact price RPM and the wholesale price contracts.
We conclude that a price-setting manufacturer may capture a max Πm (w, p) = (w − c)q(w, p). (2)
w,p
smaller share of the total supply chain profit compared to the
retailer despite the manufacturer’s ability to set the retail price. Since q = d(p)z and w = pF̄ (z(w, p)), problem (2) can be
However, we also observe in the sequel (see Observation 1 in reformulated in terms of z as
Section 3) that the manufacturer’s profit is always higher with an max Πm (z , p) = d(p)[pF̄ (z) − c ]z .
RPM contract compared to a wholesale price contract. z ,p

The rest of the paper is organized as follows. In Section 2, we We first consider the problem maxp Πm (z , p) for a fixed z > 0 and
present an analysis of the exact price RPM contract. In Section 3, show that it has a unique optimal solution p(z).
we compare the exact price RPM and wholesale price contracts.
Lemma 1. Assume that
2. Analysis of exact price RPM contracts (A1) Ed(p) is nondecreasing for p > 0 and limp→p0 Ed(p) > 1.
Then, for any fixed z > 0, Πm (z , p) is unimodal in p and there
We consider a two-stage supply chain with one retailer and one exists a unique optimal solution p(z) > 0 which maximizes Πm (z , p)
manufacturer producing a single product purchased by the retailer. in p. Moreover, p(z) is strictly increasing in z.
The manufacturer acts as a Stackelberg leader and determines both
the wholesale price and the retail price. Subsequently, the retailer, Proof of Lemma 1. For a fixed z > 0, we consider the problem
who faces uncertain demand, determines the order quantity in the maxp Πm (z , p). Then,
newsvendor framework. Afterwards, the actual demand is realized
according to a multiplicative price-dependent demand function. ∂ Πm (z , p)/∂ p = d′ (p)[pF̄ (z)z − cz ] + d(p)F̄ (z)z
This exact price RPM contract is a generalization of the two-stage c
model in [8] where an exogenous retail price is assumed. = d(p){−Ed(p)[F̄ (z) − ]z + F̄ (z)z }, (3)
p
The retail price is p > 0, the manufacturer’s unit cost is c > 0,
c < p, the wholesale price is w , c ≤ w ≤ p, and the retailer where Ed(p) > 0 since d′ (p) < 0. This implies that ∂ Πm (z , p)/∂ p =
order quantity is q. In order to simplify the exposition, we assume 0 is equivalent to
zero salvage value and zero shortage cost (the salvage value can be c
Ed(p)[F̄ (z) − ] = F̄ (z). (4)
easily incorporated in our model). Both supply chain participants p
are assumed to be risk-neutral. The multiplicative price-dependent
In view of (3),
demand is given by D(p) = d(p)D0 , where d(p) is the deterministic
price–demand function and D0 is a random variable (shock). We ∂ 2 Πm (z , p)/∂ p2 = d′′ (p)[pF̄ (z)z − cz ] + 2d′ (p)F̄ (z)z ,
assume that d(p) is twice continuously differentiable in p and that
and thus, in view of (4),
d′ (p) < 0 for p ≥ 0. Since d(p) is strictly decreasing in p, either
d(p) > 0 for all p > 0 or d(p0 ) = 0 for some p0 > 0. We define pF̄ (z)z
p0 = ∞ if d(p) > 0 for all p > 0. As in [14], we consider the feasible ∂ 2 Πm (z , p)/∂ p2|∂ Πm (z ,p)/∂ p=0 = d′′ (p) + 2d′ (p)F̄ (z)z
Ed(p)
range (0, p0 ) of p in the sequel.
For a nonincreasing demand function d(p), we define the elas-
= −d′ (p)[C (p) − 2]F̄ (z)z . (5)
pd′ (p)
ticity of d(p) as Ed(p) = − d(p) and the elasticity of the slope of The condition that Ed(p) is nondecreasing in (A1) (that is, that
1
pd′′ (p) d[Ed(p)]/dp ≥ 0) is equivalent to C (p) ≤ 1 + Ed(p) . Thus, for any
d(p) as Ed′ (p) = − d′ (p) . Observe that for the isoelastic demand
function d(p) = ap−b , a > 0, b > 1, Ed(p) = b and Ed′ (p) = b + 1. p > 0 which satisfies (4), Ed(p) > 1 and C (p) ≤ 1 + 1
Ed(p)
< 2.
Ed′ (p)
We also define the curvature of d(p) as C (p) = Ed(p) (this concept Therefore, since d (p) < 0, ∂ Πm (z , p)/∂ p|∂ Πm (z ,p)/∂ p=0 < 0 in
′ 2 2

was utilized in [3,14]).
The random variable D0 has cdf F (x), F̄ (x) = 1 − F (x), and pdf
f (x) with support on [0, ∞) so that f (x) = 0 for x < 0 and f (x) > 0
for x ≥ 0. We assume that f (x) is twice differentiable for x > 0 and
∫∞
that the mean µ = 0 xf (x)dx is finite. The failure rate is defined
f (x)
as h(x) = F̄ (x) and the generalized failure rate as g(x) = xh(x);
we assume that g(0+ ) = limx→0+ g(x) = 0. F is IFR (increasing
failure rate) if h′ (x) ≥ 0 and F is DFR (decreasing failure rate)
if h′ (x) ≤ 0 [2]; F is IGFR (increasing generalized failure rate) if
g ′ (x) ≥ 0 [8]; similarly, F is DGFR (decreasing generalized failure
rate) if g ′ (x) ≤ 0. The∫partial expected value of x with upper limit z
z unique optimal solution p(z) ∈ (0, p0 ) which maximizes Πm (z , p)
is defined as G(z) = 0 xf (x)dx. We assume throughout the paper
that F is IGFR.
For fixed w and p, the retailer’s newsvendor problem is
max Πr (q) = pE [min(q, d(p)x)] − w q.
q
q
Let q = d(p)z, where z = d(p) is the stocking factor as in [11]. Then,
the retailer’s newsvendor problem (1) can be written in terms of z
as maxz Πr (z) = d(p)[pS(z) − w z ], where S(z) = E [min(z , x)], and
has a unique optimal solution given by z(w, p) = F̄ −1 ( wp ). Since
view of (5). This implies that Πm (z , p) is unimodal in p for any
fixed z > 0. We will now show that there exists a unique optimal
solution p(z) > 0 which maximizes Πm (z , p) in p for any fixed
z > 0.
Let 0 < p ≤ F̄ (z) c
. Then, pF̄ (z)z − cz ≤ 0 and, in view
of (3), ∂ Πm (z , p)/∂ p > 0. On the other hand, by (A1) for large
enough p ∈ (0, p0 ), −Ed(p)[F̄ (z) − pc ]z < −F̄ (z)z and thus
∂ Πm (z , p)/∂ p < 0. Since, for any fixed z > 0, Πm (z , p) is unimodal
in p, ∂ Πm (z , p)/∂ p > 0 for some small p > 0, ∂ Πm (z , p)/∂ p < 0
for some large p ∈ (0, p0 ) and ∂ Πm (z , p)/∂ p is continuous in p;
therefore, we conclude that, for any fixed z > 0, there exists a
in p and is such that ∂ Πm (z , p(z))/∂ p = 0. Thus, (4) implies that
c
F̄ (z) − p(z) > 0 so that p(z) > F̄ (z)
c
> c and Ed(p(z)) = F̄ (z)F̄−(z) c > 1.
p(z)
Moreover, C (p(z)) < 2.
(1) Consider the function H(z , p) = ∂ Πm (z , p)/∂ p. Since H(z , p(z))
= 0 and, in view of (5) and the observation that C (p(z)) < 2,
∂ H(z , p(z))/∂ p = −d′ (p(z))[C (p(z)) − 2]F̄ (z)z < 0,
the implicit function theorem implies that p(z) is continuously
differentiable in z.
 G.J. Kyparisis, C. Koulamas / Operations Research Letters 46 (2018) 373–378 375

Since for any z > 0, ∂ Πm (z , p(z))/∂ p = 0, define the function Proof of Theorem 1. Since, for any z > 0, ∂ Πm (z , p(z))/∂ p = 0,
H(z) = ∂ Πm (z , p(z))/∂ p = 0 and observe that H ′ (z) = 0. Thus,
dΠm (z)/dz = ∂ Πm (z , p(z))/∂ z + ∂ Πm (z , p(z))/∂ p · p′ (z)
H ′ (z) = d{∂ Πm (z , p(z))/∂ p}/dz
= d(p(z)){p(z)F̄ (z)[1 − g(z)] − c }. (7)
= d{ d′ (p(z))[p(z)F̄ (z)z − cz ] + d(p(z))F̄ (z)z }/dz
= d′′ (p(z))p′ (z)[p(z)F̄ (z)z − cz ] This implies that the first order condition dΠm (z)/dz = 0 is
equivalent to
+ d′ (p(z))[p′ (z)F̄ (z)z − p(z)f (z)z + p(z)F̄ (z) − c ]
+ d′ (p(z))p′ (z)F̄ (z)z + d(p(z))[−f (z)z + F̄ (z)] = 0. p(z)F̄ (z)[1 − g(z)] = c . (8)
′
In view of (3), H(z) = 0 is equivalent to d (p(z))[p(z)F̄ (z)z − cz ] = Since
−d(p(z))F̄ (z)z. Thus,
d2 Πm (z)/dz 2 = d′ (p(z))p′ (z){p(z)F̄ (z)[1 − g(z)] − c }
′ d(p(z)) ′′ ′
H (z) = − d (p(z))p (z)F̄ (z)z + d(p(z)){p′ (z)F̄ (z)[1 − g(z)] − p(z)f (z)[1 − g(z)]
d′ (p(z))
− p(z)F̄ (z)g ′ (z)},
+ d′ (p(z))[p′ (z)F̄ (z)z − p(z)f (z)z + p(z)F̄ (z) − c ]
+ d′ (p(z))p′ (z)F̄ (z)z + d(p(z))[−f (z)z + F̄ (z)] in view of (8),
d(p(z)) d(p(z))
= p′ (z){− d′′ (p(z))F̄ (z)z + 2d′ (p(z))F̄ (z)z } d2 Πm (z)/dz|2dΠm (z)/dz =0 = {F̄ (z)[1 − g(z)]
d′ (p(z)) z
+ d′ (p(z))[−p(z)f (z)z + p(z)F̄ (z) − c ] × [p′ (z)z − p(z)g(z)] − p(z)F̄ (z)g ′ (z)z }.
+ d(p(z))[−f (z)z + F̄ (z)]. Thus, d2 Πm (z)/dz|2dΠm (z)/dz =0 < 0 is equivalent to
′
Since d (p(z))[p(z)F̄ (z)z − cz ] = −d(p(z))F̄ (z)z,
[1 − g(z)][p′ (z)z − p(z)g(z)] − p(z)g ′ (z)z < 0;
H ′ (z) = p′ (z)d′ (p(z))[−C (p(z)) + 2]F̄ (z)z − d′ (p(z))p(z)f (z)z
since, in view of (8), 1 − g(z) > 0, this can be written as
− d(p(z))f (z)z = 0
g ′ (z)z
and p′ (z)z < p(z)g(z) + p(z) .
1 − g(z)
−d′ (p(z))p(z)f (z)z − d(p(z))f (z)z = −d′ (p(z))p(z)F̄ (z)g(z) In view of (6), this can be stated as
− d(p(z))F̄ (z)g(z) cg(z) g ′ (z)z
= −d′ (p(z))p(z)F̄ (z)g(z) + d′ (p(z))[p(z)F̄ (z) − c ]g(z) [−C (p(z)) + 2]−1 < p(z)g(z){1 + }. (9)
F̄ (z) g(z)[1 − g(z)]
= −d′ (p(z))cg(z).
In view of (8), (9) can be written as
By combining these two expressions, g ′ (z)z
′ ′ ′ ′ [−C (p(z)) + 2]−1 [1 − g(z)] < 1 +
H (z) = p (z)d (p(z))[−C (p(z)) + 2]F̄ (z)z − d (p(z))cg(z) g(z)[1 − g(z)]
= d (p(z)){p (z)[−C (p(z)) + 2]F̄ (z)z − cg(z)} = 0.
′ ′
=1+
Eg(z)
, (10)
1 − g(z)
Thus,
zg ′ (z)
cg(z) where Eg(z) = g(z)
. Since, C (p(z)) < 2, (10) can be written as
′ −1
p (z) = [−C (p(z)) + 2] (6)
F̄ (z)z
[1 − g(z)]2 < [−C (p(z)) + 2][1 − g(z) + Eg(z)]. (11)
and p (z) > 0 since C (p(z)) < 2. This completes the proof.
′
Thus, d Πm (z)/
2
< 0 is equivalent to (11).
dz|2dΠm (z)/dz =0
In the sequel, we use the superscript ∗ to denote the equilibrium The IGFR assumption on F implies that g ′ (x) ≥ 0 for x > 0 and
quantities (unless stated otherwise).
thus Eg(x) ≥ 0 for x > 0. Thus, if
Since, for a fixed z > 0, there exists a unique optimal solution
p(z) for the problem maxp Πm (z , p), we consider the manufac- 1 − g(z) < −C (p(z)) + 2 (12)
turer’s optimization problem in z
holds for z > 0, then (11) also holds for z > 0. In view of (4) and
max Πm (z) = Πm (z , p(z)) = d(p(z))[p(z)F̄ (z) − c ]z . (8),
z

c 1
Theorem 1 (Existence/Uniqueness of an Equilibrium). Assume that 1 − g(z) = =1−
limx→∞ g(x) ≥ 1 and that either p(z)F̄ (z) Ed(p(z))
(A2) d[Ed(p)]/dp > 0 and limp→p0 Ed(p) > 1, or so that (12) is equivalent to 1 − 1
< −C (p(z)) + 2, or, to
(A3) Ed(p) = b > 1 and g(x) is strictly increasing, that is g ′ (x) > 0 Ed(p(z))
C (p(z)) < 1 + 1
.
for x > 0. Ed(p(z))
Then, there exists a unique optimal solution z ∗ > 0 which maxi- If (A2) holds, then C (p) < 1 + 1
Ed(p)
for p > 0 which implies
mizes Πm (z). Thus, there exists a unique equilibrium (q∗ , p∗ , w ∗ ) for that C (p(z)) < 1 + 1
Ed(p(z))
and that (11) holds. If (A3) holds, then
the two-stage RPM contract such that d(p) = ap−b , a > 0, b > 1, C (p) = 1 + 1
= 1+ 1
and
b Ed(p)
1 1
thus 1 − g(z) = 1 − = −C (p(z)) + 2. However, since (A3)
q∗ = d(p∗ )z ∗ , p∗ F̄ (z ∗ )[1 − g(z ∗ )] = c , Ed(p∗ ) = , Ed(p)
g(z ∗ ) implies that g ′ (x) > 0 for x > 0, Eg(x) > 0 for x > 0 and therefore
w∗ = p∗ F̄ (z ∗ ) (11) holds. Thus, under either (A2) or (A3), (11) holds. This, in turn,
implies that d2 Πm (z)/dz|2dΠm (z)/dz =0 < 0 holds and thus Πm (z) is
and the equilibrium profits are Πr∗ = d(p∗ )p∗ G(z ∗ ), Πm∗ = d(p∗ )p∗ unimodal in z. We will now show that there exists a unique optimal
F̄ (z ∗ )g(z ∗ )z ∗ . solution z ∗ > 0 which maximizes Πm (z).
376 G.J. Kyparisis, C. Koulamas / Operations Research Letters 46 (2018) 373–378

for any z > 0. Thus, in view

p(z)F̄ (z)
In view of (4), p(z)F̄ (z) − c = Ed(p(z))
Our next proposition specifies when the manufacturer captures
of (7), less than half of the supply chain total profit in the exact price RPM
contract (see also Example 1).
dΠm (z)/dz = d(p(z)){p(z)F̄ (z)[1 − g(z)] − c }
p(z)F̄ (z) Proposition 1 (Division of Supply Chain Profits). The profit ratio is
= d(p(z)){ − p(z)F̄ (z)g(z)} Πm∗
Ed(p(z)) Πr∗
= EG(z ∗ ). Thus, if either F is IFR or G(x) is convex for x ≥ 0 such
1 that g(x) ≤ 1, then Πm∗ ≥ Πr∗ ; if G(x) is concave for x ≥ 0 such that
= d(p(z))p(z)F̄ (z)[ − g(z)]. g(x) ≤ 1, then Πm∗ ≤ Πr∗ .
Ed(p(z))
Since, by (6), p′ (z) > 0, p(z) is strictly increasing in z and thus, by Proof of Proposition 1. In view of Theorem 1, Πr∗ = d(p∗ )p∗ G(z ∗ ),
(A2), Ed(p(z)) is nondecreasing in z. Let zp > 0 be arbitrary. Then, Πm∗ = d(p∗ )[p∗ F̄ (z ∗ ) − c ]z ∗ = d(p∗ )p∗ F̄ (z ∗ )g(z ∗ )z ∗ and
[Ed(p(z))]−1 ≥ [Ed(p(zp ))]−1 for 0 < z ≤ zp . Since g(0+ ) = 0,
g(z) < [Ed(p(zp ))]−1 ≤ [Ed(p(z))]−1 for small enough z > 0 which Πm∗ d(p∗ )p∗ F̄ (z ∗ )g(z ∗ )z ∗ [f (z ∗ )z ∗ ]z ∗ G′ (z ∗ )z ∗
= = = = EG(z ∗ ).
therefore implies that dΠm (z)/dz = d(p(z))p(z)F̄ (z)[ Ed(p(z)) 1
− Πr∗ ∗ ∗
d(p )p G(z ) ∗ G(z )∗ G(z ∗ )
g(z)] > 0 for small enough z > 0. Moreover, since we assume
If G(x) is convex (concave) for x ≥ 0 such that g(x) ≤ 1, then
that limx→∞ g(x) ≥ 1 and limp→p0 Ed(p) > 1, for large enough
G(0) − G(x) ≥ (≤) G′ (x)(0 − x), which can be written as G′ (x)x ≥
z > 0 such that p(z) ∈ (0, p0 ), we have that g(z) > Ed(p(z)) 1
and (≤) G(x), or, equivalently as EG(x) ≥ (≤) 1, and thus, since q∗ > 0
thus dΠm (z)/dz = d(p(z))p(z)F̄ (z)[ Ed(p(z))
1
− g(z)] < 0. Π∗
and g(q∗ ) < 1, Πm∗ ≥ (≤) 1. This completes the proof.
Since Πm (z) is unimodal in z, dΠm (z)/dz > 0 for some small r

z > 0, dΠm (z)/dz < 0 for some large z > 0 such that p(z) ∈ (0, p0 )
and dΠm (z)/dz is continuous in z; therefore, we conclude that
there exists a unique optimal solution z ∗ > 0 which maximizes
Πm (z) and is such that dΠm (z ∗ )/dz = 0. Also, in view of (4) and
(8),
c F̄ (z ∗ )
F̄ (z ∗ ) − = = F̄ (z ∗ )g(z ∗ )
p(z ∗ ) Ed(p(z ∗ ))
1
which implies that Ed(p(z ∗ )) = . This completes the proof.
g(z ∗ )
Theorem 1 extends Theorem 4 in [10] in two ways. First, we
prove Theorem 1 for general price–demand functions and all IGFR
distributions under assumption (A2). Second, we prove Theorem 1
for the isoelastic price–demand function d(p) = ap−b , a > 0, b > 1,
for which Ed(p) = b, under assumption (A3) which only requires
that F is strictly IGFR compared to the more restrictive assumption
in Theorem 4 in [10] that F is IFR.
Assumption (A2) is slightly more restrictive than (A1) by requir-
ing that Ed(p) is strictly increasing instead of requiring that Ed(p) is
nondecreasing. The second part of (A1) requires that Ed(p) > 1
for large enough p. Observe that (A2) and (A3) both imply (A1).
Also, the condition that Ed(p) is nondecreasing is equivalent to
Ed′ (p) 1
C (p) = Ed(p) ≤ 1 + Ed(p) .
In general, conditions (A1) and (A2) are satisfied by a number
of price–demand functions (see [14,16]). Song et al. [14] list the
following deterministic price–demand functions:
isoelastic price–demand function d1 (p) = ap−k (a > 0, k > 1),
d2 (p) = (a − kp)γ (a > 0, k > 0, γ > 0),
d3 (p) = ae−kp (a > 0, k > 0),
d4 (p) = a − pk (a > 0, k > 1),
d5 (p) = a − ekp (a > 1, k > 0).
γ kp
One can verify that Ed1 (p) = k, Ed2 (p) = a−kp , Ed3 (p) = kp,
kpk kpekp
Ed4 (p) = a−pk and Ed5 (p) = a−ekp . Since Ed1 (p) = k > 1,
d1 (p) satisfies (A3). It is easy to see that d[Edi (p)]/dp > 0 for
i = 2, 3, 4, 5, and that limp→p0 Ed2 (p) = ∞ > 1 with p0 = ak ,
limp→p0 Ed3 (p) = ∞ > 1 with p0 = ∞, limp→p0 Ed4 (p) = ∞ > 1
with p0 = a1/k , limp→p0 Ed5 (p) = ∞ > 1 with p0 = 1k ln(a), so
that di (p), i = 2, 3, 4, 5, all satisfy (A2). The linear price–demand
function d(p) = a − kp is a special case of d2 (p) with γ = 1 and
is defined on the feasible range (0, ak ). Similarly, the price–demand
functions di (p), i = 4, 5, are defined on finite ranges (0, p0 ).
The conditions that g(x) is strictly IGFR and limx→∞ g(x) ≥
1 are satisfied by almost all IGFR distributions which include
the uniform, normal and exponential distributions among others
(see [1]). The assumption limx→∞ g(x) ≥ 1 is needed to assure that
maxz Πm (z) has a finite solution z ∗ .
The assumption that F is IFR which implies that Πm∗ ≥ Πr∗
is satisfied by a large number of common statistical distributions
such as the uniform, normal and exponential distributions (see [1]).
All IFR distributions are clearly also IGFR. If G(x) is convex for x ≥ 0,
then F is IGFR. Proposition 1 indicates that the division of supply
chain profits depends on the curvature of G(x). In the following
example, the manufacturer realizes a lower profit than the retailer
in an exact price RPM contract.
Example 1. Let f (x) = kxk−1 exp(−xk ) be the pdf for the Weibull
distribution with k = 0.5 (which is strictly IGFR but not IFR and
for which Eg ′ (x) ≥ −1 for x > 0 holds) and let d(p) = p−b ,
Π∗
b > 1, be the isoelastic price–demand function. Then, Πm∗ =
r
4
exp(− 2b )
b3
and one can show numerically that Πm∗ < Πr∗
2−[ 42 + 4b +2] exp(− 2b )
b
for b < 1.38.
The outcome of Example 1 shows that despite the manufac-
turer’s ability to set the retail price, she does not always realize
a higher profit than the retailer. This is because the manufacturer
is more interested in maximizing the value of her expected profit
rather than her share of the profit in the supply chain.
3. Comparison of exact price RPM and wholesale price con-
tracts
The wholesale-price two-stage model with variable retail price
p (determined by the retailer) and multiplicative price-dependent
demand was analyzed in [14,16]. Song et al. [14] also assumed that
the manufacturer engages in buybacks. We use the superscripts
‘‘u’’ and ‘‘d’’ to indicate the equilibrium quantities of interest in the
upstream pricing (exact price RPM) and the downstream pricing
(wholesale price) contracts respectively.
Observation 1. The manufacturer’s equilibrium profit for the
exact price RPM contract is at least as large as the manufacturer’s
equilibrium profit for the wholesale price contract.
Proof of Observation 1. Suppose that (qd , pd , w d ) is the equilib-
rium solution of the wholesale price contract so that (pd , qd ) is the
solution of the retailer maximization problem maxp,q Πr (p, q) =
pE [min(q, d(p)x)] − w d q with the corresponding manufacturer’s
profit Πm (w d ) = (w d − c)qd . For the exact price RPM contract,
assume that the manufacturer selects a feasible solution (w d , pd ) of
the maximization problem maxw,p Πm (w, p) = (w − c)q. Then, the
retailer will necessarily select the optimal solution q = qd of the
resulting maximization problem maxq Πr (q) = pd E [min(q, d(pd )x)]
 G.J. Kyparisis, C. Koulamas / Operations Research Letters 46 (2018) 373–378 377

−wd q. Thus, the manufacturer achieves the profit Πm (wd ) = (wd − strictly increasing for x > 0, z u < z d . Since pu = bc
(b−1)F̄ (z u )
and
d
c)q for the exact price RPM contract with the feasible solution p = d bc
, z < z implies that p < p .
u d u d
(b−1)F̄ (z d )
(qd , pd , w d ) which is the equilibrium solution for the wholesale
Define the functions Hr (x) = [F̄ (x)]b−1 G(x) and Hm (x) = [F̄ (x)]b x
price contract and therefore the manufacturer’s equilibrium profit
for x > 0 so that Hr′ (x) = [F̄ (x)]b−2 f (x)[S(x) − bG(x)] and Hm
′
(x) =
for the exact price RPM contract is at least as large as the manu- d
facturer’s equilibrium profit for the wholesale price contract. This [F̄ (x)]b [1 − bg(x)] respectively. Since g(z u ) = 1b and G(z )
S(z d )
= 1b ,
′ d ′ u G(x)
completes the proof. Hr (z ) = 0 and Hm (z ) = 0. Since g(x) and S(x) are strictly
increasing for x > 0, Hr′ (x) < 0 for x > z d , Hr′ (x) > 0 for x < z d ,
Observation 1 is intuitive because the manufacturer has the
Hm ′
(x) < 0 for x > z u and Hm ′
(x) > 0 for x < z u . Thus, Hr (x) is
option of setting the retail price in an RPM contract at the level
strictly increasing for x < z d and strictly decreasing for x > z d ;
chosen by the retailer in the wholesale price contract but she also Hm (x) is strictly increasing for x < z u and strictly decreasing for
has additional pricing options to increase her profits. x > z u . This implies that Hr (x) is maximized at z d and Hm (x) is
maximized at z u . Observe that Πru = C1 Hr (z u ), Πrd = C1 Hr (z d ),
Proposition 2. Assume that either b −1
Πmu = C2 Hm (z u ), Πmd = C2 Hm (z d ), where C1 = c ba−1 (b−bb1)−1
(1) d[Ed(p)]/dp > 0 and F is the uniform distribution U [0, a], or
a (b−1)b−1
(2) d(p) = ap−b , a > 0, b > 1 and F is IGFR. and C2 = c b−1 bb
. Thus we conclude that Πru < Πrd and
Then, if the upstream (RPM with exact price) and downstream Πmu > Πmd . Moreover, since qu = C1 [F̄ (z u )]b z u = C1 Hm (z u ),
(wholesale price) pricing models have unique equilibria (qu , pu , w u ) d
q = [ C1 F̄ (z d ) b z d
] = C1 Hm (z d ) and Hm (z u ) > Hm (z d ), we obtain
and (qd , pd , w d ) respectively, then pu < pd . Moreover, if d(p) = ap−b , that q > q .
u d

a > 0, b > 1, then w u = w d = bbc , qu > qd , Πru < Πrd , Πmu > Πmd , We can show that the total profit Πru + Πmu can be either larger
−1
and Πr + Πm can be either larger or smaller than Πrd + Πmd .
u u or smaller than the total profit Πrd + Πmd . Let f (x) = 1 be the
pdf of the [0, 1] uniform distribution. Then, z u = b+1 1 , z d = b+2 1 ,
b
Proof of Proposition 2. Assume first that d[Ed(p)]/dp > 0 ΠTu = Πru + Πmu = 0.5C1 (b+3b1)b+1 and ΠTd = Πrd + Πmd =
and F is the U [0, a] uniform distribution, where, without loss of 4(b−1)b−1 (2b−1)
0.5C1 . It follows that ΠTu > ΠTd for b > 2, ΠTu < ΠTd
generality, we let a = 1. Then, the equilibrium (qu , pu , w u ) for the (b+1)b+1

RPM contract satisfies the conditions pu F̄ (z u )[1 − g(z u )] = c and for 1 < b < 2 and ΠTu = ΠTd for b = 2. This completes the proof.
Ed(pu ) = g(z1u ) , where qu = d(pu )z u . By solving these two equations Proposition 2 extends Corollary 2 in [10] in two ways. First,
we obtain that pu satisfies the equation pu = [1 + 2
]c and is we prove Proposition 2 under assumption (1) for general price–
Ed(pu )−1
pu +c demand functions and uniformly distributed random demand. Sec-
such that Ed(pu ) = pu −c > 1. ond, we prove Proposition 2 with assumption (2) for the isoelastic
Consider the equilibrium (qd , pd , w d ) for the wholesale price price–demand function and the class of IGFR distributions com-
S(z d )
contract. It satisfies the equation Ed(pd ) = G(z d ) and, for the U [0, 1] pared with the more restrictive class of IFR distributions in [10].
distribution, pd solves the following manufacturer’s maximization Proposition 2 with assumption (2) reaffirms Corollary 2 (parts
2, 3) in [10] and shows that the Stackelberg leader manufacturer
problem
always realizes a higher profit with an RPM contract compared to
Ed(p) − 1 2 a wholesale price contract. Proposition 2 suggests that the man-
max Πm (p) = d(p )[ p − c ][ ].
p Ed(p) + 1 Ed(p) + 1 ufacturer has a stronger interest than the retailer to offer a lower
retail price to the market to induce higher sales even though our
Ed(pd )−1
Since Πm (pd ) > 0, pd − c > 0, or equivalently, pd >
Ed(pd )+1
model does not consider product competition at the retailer level.
[1 + ] Since d[Ed(p)]/dp > 0, Ed(p) is strictly increasing
2
c. In the remainder of this section, we compare the consumer
Ed(pd )−1 surplus and the total system welfare for the RPM and the wholesale
and, since p = [1 + Ed(p2u )−1 ]c and pd > [1 + Ed(p2d )−1 ]c, one
u
price contracts with the isoelastic price–demand function. Con-
can show by contradiction that pu < pd (which also implies that sumer welfare is often measured by the consumer surplus defined
Ed(pu ) < Ed(pd )). as the consumer gain due to the difference between what con-
Assume next that d(p) = ap−b , a > 0, b > 1. It was sumers are willing to pay and the actual market price. This notion
shown in [14,16] that the unique equilibrium (qd , pd , w d ) of the is well defined for a general deterministic price–demand curve as
downstream pricing model is given by qd = d(pd )z d , pd = (b−1)bcF̄ (z d ) , the area under the demand curve above the market price [15].
Cohen et al. [4] point out that the definition of consumer surplus
S(z d )
G(z d )
= b, w d = pd F̄ (z d ) = bbc −1
, Πrd = d(pd )pd G(z d ) and is more complicated when the demand is uncertain due to the
Πmd d d d d c
= d(p )[p F̄ (z ) − c ]z = b−1 d(pd )z d . In view of Theorem 1 possibility of stockouts. In accordance with [4], we define the
and since Ed(p) = b, the unique equilibrium (qu , pu , w u ) of the consumer surplus for a given random demand realization x as
upstream pricing model is given by qu = d(pu )z u , pu = (b−1)bcF̄ (z u ) , min(D(p, x), q)
CS(x) = CS max (x) · , (13)
g(z u ) = 1b , w u = pu F̄ (z u ) = bbc
−1
, Πru = d(pu )pu G(z u ) and D(p, x)
Πm = d(p )[p F̄ (z ) − c ]z = b−1 d(p )z .
u u u u u c u u ∫ pmax(x)
where CS max (x) = p D(p, x)dp is the maximum consumer
Since we assume that F is IGFR, it follows from Lemma 1 in [16] surplus, D(p, x) is the demand for given p and x, pmax (x) is the
that g(x) > S(x) for x > 0. Observe that
G(x)
min(D(p,x),q)
maximum price with nonnegative demand and D(p,x)
is the
G(x) G′ (x)S(x) − G(x)S ′ (x) f (x)xS(x) − G(x)F̄ (x) proportion of served customers for given p, x and q. The expected
d[ ]/dx = = consumer surplus for a given x is E [CS(x)].
S(x) [S(x)]2 [S(x)]2
In our model, D(p, x) = d(p)x, where d(p) > 0 for all p > 0 so
F̄ (x) G(x) ∫∞
= [g(x) − ]. that pmax (x) = ∞ for all x ∈ [0, ∞) and CS max (x) = x p d(p)dp.
S(x) S(x) min(D(p,x),q) min(x,z)
Since q = d(p)z, D(p,x)
= x
and, by (13), CS(x) =
∫∞
Thus, g(x) > for x > 0 if and only if d [ ]/dx > 0 for
G(x) G(x)
S(x) S(x) [ p
d(p)dp ] · min(x, z). Thus, the expected consumer surplus is
x > 0, which implies that is strictly increasing for x > 0. Since
G(x) ∫ ∞ ∫ ∞
S(x)
1 G(z d ) E [CS(x)] = [ d(p)dp ] · E [min(x, z)] = [ d(p)dp ] S(z). (14)
g(x) > for x > 0 and g(x) and
u 1 G(x) G(x)
g(x ) = ,
b S(z d )
= b
, S(x) S(x)
are p p
378 G.J. Kyparisis, C. Koulamas / Operations Research Letters 46 (2018) 373–378

Table 1
E [CS u (x)] and E [CS d (x)] for d(p) = ap−b and the exp(1) distribution.
b 1.1 1.3 1.35 1.4 2 3 4 5 10
E [CS u (x)] 4.290 0.915 0.719 0.581 0.119 0.032 0.015 0.008 0.0017
E [CS d (x)] 5.284 0.940 0.719 0.568 0.102 0.026 0.011 0.006 0.0012

Proposition 3. Assume that d(p) = ap−b , a > 0, b > 1 and F is IGFR. value for the case of exponentially distributed random demand.
Then, the expected consumer surplus values for the upstream (RPM) Finally, the total system welfare is higher with an exact price RPM
and the downstream (wholesale price) contracts at the equilibrium clause for an isoelastic price–demand function with b > 1.35 and
(qu , pu , w u ) and (qd , pd , w d ) respectively are given as exponentially distributed random demand.
a b−1
E [CS ∗ (x)] = ( )( )b−1 [F̄ (z ∗ )]b−1 S(z ∗ ), Acknowledgments
b−1 bc
where ∗ = u for the upstream model and ∗ = d for the downstream We would like to thank the area editor and the anonymous
model. Thus, reviewer for their valuable comments which helped us improve an
E [CS u (x)] [F̄ (z u )]b−1 S(z u ) earlier version of the paper.
=
E[ CS d (x)] [F̄ (z d )]b−1 S(z d ) References
and E [CS u (x)] may be larger or smaller than E [CS d (x)].
[1] M. Banciu, P. Mirchandani, New results concerning probability distributions
with increasing generalized failure rates, Oper. Res. 61 (2013) 925–931.
Proof of Proposition 3. Since d(p) = ap−b , [2] R.E. Barlow, F. Proschan, Statistical Theory of Reliability and Life Testing Holt,
∞
ap−b+1 Rinehart and Winston, Inc., 1975.
∫
a 1
d(p)dp = [ ]∞
p∗ = ( )(p∗ )−b+1 = d(p∗ )p∗ . [3] T.F. Bresnahan, P.C. Reiss, Dealer and manufacturer margins, Rand J. Econ. 16
p∗ −b + 1 b−1 b−1 (1985) 253–268.
[4] M.C. Cohen, R. Lobel, G. Perakis, The impact of demand uncertainty on
Since p∗ = bc
(b−1)F̄ (z ∗ )
, ∗ = u, d, (14) implies that consumer subsidies for green technology adoption, Manage. Sci. 62 (2015)
∫ ∞ 1235–1258.
a b−1 [5] K.G. Elzinga, D.E. Mills, The economics of resale price maintenance, in: 3 Issues
E [CS ∗ (x)] = [ d(p)dp ] · S(z ∗ ) = ( )( )b−1
b+1 bc in Competition Law and Policy 1841 (ABA Section of Antitrust Law), 2008.
p∗
[6] H. Gurnani, Y. Xu, Resale price maintenance contracts with retailer sales effort:
× [F̄ (z ∗ )]b−1 S(z ∗ ). effect of flexibility and competition, Nav. Res. Logist. 53 (2006) 448–463.
[7] H. Krishnan, R.A. Winter, Vertical control of price and inventory, Amer. Econ.
For the exponential distribution exp(1), the numerical results dis- Rev. 97 (2007) 1840–1857.
played in Table 1 show that E [CS u (x)] > E [CS d (x)] for b > 1.35 and [8] M.A. Lariviere, E.L. Porteus, Selling to the newsvendor: An analysis of price-
E [CS u (x)] < E [CS d (x)] for b < 1.35. only contracts, Manuf. Serv. Oper. Manage. 3 (2001) 293–305.
[9] Y. Liu, M.J. Fry, A.S. Raturi, Vertically restrictive pricing in supply chains with
The expected total system welfare (or total surplus) E [TW ] is price-dependent demand, Nav. Res. Logist. 53 (2006) 485–501.
defined as the sum of the consumer surplus, the retailer’s profit [10] Y. Liu, M.J. Fry, A.S. Raturi, Retail price markup commitment in decentralized
and the manufacturer’s profit, that is, E [TW ] = E [CS(x)]+ Πr + Πm supply chains, European J. Oper. Res. 192 (2009) 277–292.
[11] N.C. Petruzzi, M. Dada, Pricing and the newsvendor problem: A review with
for any contract. We have noted in Observation 1 that Πmu ≥ Πmd .
extensions, Oper. Res. 47 (1999) 183–194.
Numerical experiments for the exponential distribution indicated [12] P. Rey, J Tirole, The logic of vertical restraints, Amer. Econ. Rev. 76 (1986)
that the expected total system welfare is larger for the exact price 921–939.
RPM contract for all b > 1.35 values. [13] P. Rey, T. Verge, The Economics of Vertical Restraints, in: Presented at the
In summary, the comparison of the RPM and wholesale price conference Advances of the Economics of Competition Law, Rome, Italy, 2005.
contracts indicates that an exact price RPM clause is always ben- [14] Y. Song, S. Ray, S. Li, Structural properties of buyback contracts for price-setting
newsvendors, Manuf. Serv. Oper. Manage. 10 (2008) 1–18.
eficial to the manufacturer and provides an immediate benefit
[15] X. Vives, Oligopoly Pricing: Old Ideas and New Tools, MIT press, Cambridge,
to the consumers in the form of a lower retail price. When the MA, 2001.
consumer gain is measured by the expected consumer surplus, we [16] X. Xu, X. Cai, Y. Chen, Unimodality of price-setting newsvendor’s objective
concluded that in the case of an isoelastic price–demand function, function with multiplicative demand and its applications, Int. J. Prod. Econ.
the consumers are better off with a high price–demand elasticity 133 (2011) 653–661.