Supply Chain Choice on the Internet

Internet companies extensively use the practice of drop-shipping, where the wholesaler stocks and owns the inventory and ships products directly to customers at retailers' request. Under the drop-shipping arrangement, the supply chain benefits from risk pooling because the inventory for multiple retailers is stocked at the same location, the wholesaler's. Another more traditional channel alternative on the Internet is one in which retailers stock and own the inventory. These two supply chain structures, which predominate on the Internet, result in different inventory risk allocation, stocking decisions, and profits for channel members. Moreover, the two channel alternatives can be combined into a dual strategy whereby the retailer uses local inventory as a primary source and relies on drop-shipping as a backup. We model the dual strategy as a noncooperative game among the retailers and the wholesaler, analyze it, and obtain insights into the structural properties of the equilibrium solution to facilitate development of recommendations for practicing managers. Finally, we characterize situations in which each of three channels is preferable by specifying appropriate ranges of critical parameters, including demand variability, the number of retailers in the channel, wholesale prices, and transportation costs.