Impact of Gray Markets on Supply Chain Performance

Abstract

Abuse of channel incentives by a manufacturer’s authorized retailers often encourages gray markets to emerge which affects supply chain profit as well as manufacturer’s brand image, profit loss and cannibalization of unauthorized channel sales. Often, gray marketers enjoy free rides on sales and advertisement expenditure, hence offer a competitively lower price which incentivizes consumers to buy from unauthorized channels. In this thesis, we primarily analyze three studies. In the first study, we analyze the performance of a number of contracts in the presence of a gray market- primarily wholesale price, revenue sharing and quantity discounts and analyze their impact on prices charged, quantity ordered as well as profits. Our results indicate that selection of an appropriate contract is quite crucial, as different contracts give different results across a variety of operating parameters. Their performance is governed by the relative trade-offs involving diversion of excess quantity to the gray market at the end of the season, an extension of the target market due to lower prices in the alternate channel, and the negative impact on the manufacturer’s brand which also affects its revenue. We delineate these characteristics and find that in general, the quality discount contract performs the worst. Interestingly, if the blowback suffered by the manufacturer on account of product availability in the gray market is high, the wholesale price contract may outperform the other contracts, including the revenue sharing contract with a truthful retailer, which otherwise is a more attractive option. Therefore, myopically selecting a product distribution contract can be harmful for manufacturers...