Channel coordination and volume discounts with price-sensitive demand

We consider volume discounts and franchise fees as coordination mechanisms in a system consisting of a supplier and a buyer with demand that is price-sensitive. The problem is analyzed as a Stackelberg game in which the supplier acts as the leader by announcing its pricing policy to the buyer in advance and the buyer acts as the follower by determining his unit selling price and thus annual sales volume is determined. We compare the discounts that the supplier gives to the buyer when they work independently with that when they work jointly. It is shown that volume discounts are not sufficient to guarantee the system's profit maximization. By charging the buyer franchise fees to offset an amount equal to or more than his loss due to giving the buyer more discounts than his optimal volume discounts, the coordination and profit maximization of the supply chain can be achieved. We also compare the mechanism of employing volume discounts and franchise fees with that of employing quantity discounts and franchise fees to achieve channel coordination. When demand is price-sensitive, the channel profit achieved by employing volume discounts and franchise fees is larger than that achieved by quantity discounts and franchise fees, but the channel cycle inventory is smaller than that raised by employing quantity discounts and franchise fees. Numerical examples are provided.