Designing Price Contracts for Boundedly Rational Customers: Does the Number of Blocks Matter?

By Noah Lim, Teck-Hua Ho. Marketing science (Providence, R.I.), 2007

168 citations recorded by the source corpus.

When designing price contracts, one of the major questions confronting managers is how many blocks there should be in the contract. We investigate this question in the setting of a manufacturer-retailer dyad facing a linear deterministic consumer demand. Theoretical marketing models predict that the manufacturer's profits rise dramatically when the number of blocks in the contract is increased from one to two because both channel efficiency and its share of channel profits increase. However, increasing the number of blocks to three yields no incremental profits. We test these predictions experimentally and find that increasing the number of blocks from one to two raises channel efficiency but not the manufacturer's share of profits. Surprisingly, having three blocks in the contract increases channel efficiency even further and also gives the manufacturer a slightly higher share of profits. We show that these results can be explained by a quantal response equilibrium model in which the manufacturer accounts for noisy best response due to nonpecuniary payoff components in the retailer's utility. We also show that the retailer is sensitive to the counterfactual profits it could have earned if it were charged a lower marginal price for earlier blocks in the multiple-block contract.

Subfields: Management Information Systems, Management Science and Operations Research, Marketing

View Paper: https://www.semanticscholar.org/paper/ea5fd3b9d6d75c45993a531fcae23324311627be

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In Management Information Systems

In Management Science and Operations Research

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Citations in the corpus

Distributional and Peer‐Induced Fairness in Supply Chain Contract Design (2013, methodology): “Decision biases, such as reference dependence and loss aversion (Kahneman and Tversky 1979), have been extensively studied in the context of supply chain contracting (e.g., Ho and Zhang 2008, Ho et al. 2010, Kalkanci et al. 2011, Katok and Wu 2009, Lim and Ho 2007, Su 2008).”
Trust in Forecast Information Sharing (2011, background): “Playing both roles in the one-time-interaction treatments helps participants to learn the game faster and understand better the incentives for both parties (see Lim and Ho 2007).”
Fairness in supply chain contracts: A laboratory study (2013, background): “(Lim and Ho 2007) study 2- and 3block tariffs and find that 3-block tariffs perform better in the lab even though in theory they should not.”
The Impact of Consumer Fairness Seeking on Distribution Channel Selection: Direct Selling vs. Agent Selling (2018, background): “…seeking is also related to a growing body of literature studying the impacts of consumer social preferences on the ﬁrm strategy and proﬁtability (Amaldoss and Jain 2008, 2010, Becker 1991, Charness and Rabin 2002, Lim 2010, Lim and Ho 2007, Tereyagoglu and Veeraraghavan 2012, Wu et al. 2008).”
The Impact of Information Sharing on Supply Chain Performance under Asymmetric Information (2013, background): “Lim and Ho (2007) experimentally investigate the coordination efﬁciency of the wholesale-price contract as well as the multi-block tariff (which is similar in nature to a screening contract due to the non-linearity of the incentive scheme) in a supply chain with price-sensitive and deterministic…”
Social Preferences and Supply Chain Performance: An Experimental Study (2008, background): “tracting behavior (Katok and Wu 2006) and point to the cognitive biases missing in contracting theory (Ho and Zhang 2007, Lim and Ho 2007 ).”