Killer Creek Marketing Analytics Coordinating Partner Channels Improving total profit of supply chain
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Killer Creek Marketing Analytics
Coordinating Partner ChannelsImproving total profit of supply chain
Coordination generates greater profit
• Typical wholesale contract leaves profit on the table
• Coordination between supplier and retailer creates a larger profit pool, split between players
• Focus on getting price right in market, increasing share, splitting maximized profit pool
What problem does coordination solve?
What barriers exist, and how can they be mitigated?
Without a middleman, here is how profit is maximized
• The basic graph reproduced from any economics textbook explains how an integrated company makes maximum profit
• Recall the profit maximizing condition is that marginal cost equals marginal revenue
Simplified View
Pric
e-20
0
20
40
60
80
100
Quantity
40
DemandMarginal Revenue
Marginal Cost
Total Profit: $1,600
Integrated Supply ChainUnit Price $60
Marginal Cost $20Quantity 40Revenue $2,400
Total Cost $800Profit $1,600
A retailer’s markup reduces the total profit pool
• The market marginal revenue becomes the demand for the retailer
• The retailer’s marginal revenue causes a distortion in market price and total quantity
Retailer View
Pric
e-20
0
20
40
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Quantity
40
DemandMarginal Revenue/
Retail Demand
Marginal Cost
Supplier Profit: $800
Integrated Supply ChainRetail Unit Price $80Marginal Cost $20
Quantity 20Supply Chain Revenue $1,600
Total Cost $400Total Profit Pool $1,200
Retailer Profit: $400
20
Retailer Marginal Revenue
$400 in total profit lost through lack of coordinated chain
Ordinary coordination structures involve ex post revenue sharing
• The supplier drops price to a level that would be un-economic without coordination
• The retailer sets the price at a level that creates the largest profit pool
• Finally, that profit pool is split according to some negotiated rule
• Profit increases for both players
A coordinating arrangement would be an improvement over the retail equilibrium
Coordinated View
Pric
e
-20
0
20
40
60
80
100
Quantity
4DemandMarginal Revenue
Marginal Cost
Total Profit: $1,600
Supplier prices at marginal cost
Retailer sets price to achieve largest profit pool
Split resulting revenue according to negotiated rule
Total revenue $2,400
Total cost $800
Profit pool $1,600
Revenue splits Supplier profit Retailer profit
Supplier gets 2/3 $800 $800
Supplier gets 5/6 $1,200 $400
In this example, revenue splits will be negotiated between 2/3 and 5/6 of total — with both retailer and supplier realizing
higher profit than with a wholesale relationship
Revenue sharing agreements are in lots of places
Textbook case:
Lower price, sell more, increase
profit
Famous case:
Increase inventory, sell more, increase
profit
Hollywood case:
Control key factor of
production, increase profit
The Blockbuster revenue sharing agreement is notable and deserves a quick review here
Studios and Blockbuster moved from a wholesale price to a revenue sharing arrangement in the early 2000s
Price change
Market share
change
Profit increase
Price of videocassette dropped from $65 to $8
Share for Blockbuster increased from 24% to
40% in five years
Profit estimated to have increased 7%
In this case, the retail price did not fall, instead, the key variable was the
stock of new releases. The price changes were between retailer and supplier, while the volume increase were felt directly at the retail level
What problem does coordination solve?
What barriers exist, and how can they be mitigated?
Plenty of industries don’t leverage revenue-sharing or other coordinating agreements — why?
Tire makers
Supply auto manufacturers,
but don’t coordinate
CPG: tobacco
Fairly straightforward
retail model, uses buy-downs
for price coordination
UPS / The UPS Store
Shipping component
operates with wholesale-retail
model
Reasons why coordinating contracts are not used
Administrative costs
Inability to assign risk
Value chain delivery
There has to be a willingness and ability to share information about revenue.
Coordinating relationships change the way risk is borne in ways not always appealing to both firms
If the downstream firm delivers a significant effort in delivering to the final customer, a coordinating solution
becomes more difficultFor some of these cases, a coordinating solution is stillpossible, but requires additional levels of analysis
Coordinating structures fall into several categories
Realized revenue
Expected revenue
Normal revenue share
Sharing with cost
adjustments
Capacity purchase
Variable pricing
Supplier subsidizes retailer costs
As discussed, split ex post maximum
profit
Functionally, an ex ante revenue split
Like capacity purchase, in smaller bites
The Killer Creek approach
Understand your route-to-market and the contributions of
each link in the chain
Devise the range of coordinating arrangements
most likely to be adopted by your partners & deliver greater profit
to you
Direct and measure pilot tests
Killer Creek has the analytical and practical background necessary to drive positive change in your organization
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