2011 MSOM Annual Conference Ann Arbor, Michigan, June 26-28, 2011

Revenue Sharing and Information Leakage in a Supply Chain

Guangwen Kong

University of Souhern California

Sampath Rajagopalan

University of Southern California

Hao Zhang

University of Southern California

Revenue Sharing and Information Leakage in a Supply Chain

Guangwen Kong, Sampath Rajagopalan, Hao Zhang

Department of Information and Operations Management, Marshall School of Business

University of Southern California, Los Angeles, CA 90089

Abstract

Advances in information technology have had a dramatic impact on the ability of rms in a sup-

ply chain to share information. This has been heralded as a key part of the information revolution

and numerous rms have taken advantage of these advances. Greater collaboration between rms

in a supply chain has resulted in initiatives such as Collaborative Planning, Forecasting and Re-

plenishment (CPFR) and well-known manufacturers such as Proctor and Gamble and Black Decker

as well as major retailers such as Home Depot and Wal-Mart have participated in these eorts.

While information sharing has resulted in many benets, there have been many challenges too.

One of the major challenges has been the reluctance of some rms to share information vertically

with suppliers due to the fear of leakage of this information to their competitors. In this case, the

many benets of information sharing are not realized and all the parties in the supply chain may

be worse o.

The issue of information sharing and leakage is clearly most salient when the information is

valuable and demand information is often particularly valuable in a supply chain. One retailer may

have a considerable advantage over others in access to or in acquiring demand information and

this can be a source of signicant competitive advantage. The retailer can exploit this information

advantage for instance by producing and selling more if demand is likely to be higher and thus

achieving higher revenues. A toy retailer may be popular with young mothers and may be able to

identify market trends earlier than say discount or mass market retailers selling toys. The same

may be true for a retailer selling exclusively video games or other similar products. A retailer

may be able to exploit this informational advantage only with the cooperation of the supplier who

manufactures the product. But the advantage may dissipate if the common supplier leaks the

demand information or an equivalent signal to a competitor. While we have framed our discussion

in terms of retailers sharing information with a supplier, the same issues are salient in the context

of a manufacturer sharing information with the supplier of, say, a critical part.

2Our goal in this work is to identify contracts that enable information sharing in a supply chain

without the negative eects of information leakage. In particular, we consider a stylized supply

chain with one supplier selling to two retailers who compete for customers. One of these retailers

(the incumbent) is privy to private information about market potential and places an order based

on this information. The supplier may leak this information to the second retailer (the entrant) if

it benets her and in turn this would impact the order quantity placed by the rst retailer. The

two retailers engage in Cournot competition, i.e. they sell in a market where the price is inversely

proportional to their cumulative order quantities. Anand and Goyal (2009) analyzed an identical

scenario and showed that the supplier will always leak information under a wholesale price contract.

The information leakage may result in a less e cient supply chain with lower prots potentially for

all parties. If the supplier can make a credible commitment not to leak, the supplier might benet

from it. So, we consider what would happen if the supplier uses a revenue sharing contract wherein

she sells the product to the two retailers at a (possibly lower) wholesale price but also receives

a share of the retail revenue. Revenue sharing contracts are common in several industries and

have been shown to be eective in coordinating supply chains (Dana and Spier 2001, Cachon and

Lariviere 2005). Our objective is to explore if and when a revenue sharing contract might reduce

the suppliers incentive to leak information and the impact of such a contract on the decisions and

prots of the supplier and retailers in the supply chain. While revenue sharing contracts have been

analyzed in the literature from a supply chain coordination perspective, their role in addressing

information leakage issues have not been analyzed.

In order to nd a leakage-proof revenue sharing contract, we begin with two benchemark sce-

narios: the rst is that the suppplier can make a credible commitment not to leak the incumbents

order quantity to the entrant, and the second is that the supplier always leaks the incumbents

order quantity to the entrant. A simultaneous game is played by the two retailers if the supplier

can commit not to leak information, while a signaling game is played if the supplier always leaks.

In the latter situation, the incumbent would take into account the entrants updated belief of the

demand state and corresponding action after learning the incumbents order. The results in these

two benckmark scenarios lead us to establish the suppliers incentive comatitibility with nonleak-

age and then the incubments. To be specic, we nd a range of the incumbents order quantity in

which the supplier prefer nonleakage and the incumbents order quantity in equilibrium fall into the

suppliers nonleakage range under both high and low demand states. Furthermore, we characterize

3the set of contract parameters (wholesale price and revenue sharing rate) under which nonleakage

can be sustained.

Our analysis reveals that a revenue sharing contract leads to many interesting eects on the

actions and prots of the supplier and retailers. First, from the suppliers point of view, if the

demand information is fully shared across the supply chain, the retailers tend to over-order when

the demand is high and under-order when the demand is low. Thus, there is value for concealing that

information and letting the uninformed retailer place a moderate order, which mitigates the quantity

distortion in the supply chain. In that sense, revenue sharing help the supply chain outperform

simple Cournot with perfect information. Second, if the retailer with private demand information

does not want the supplier to leak this information, his order quantity needs to be distinguishable

(falling outside of an intermediate interval) to demonstrate the quantity distortion to the supplier.

That is, contrary to the common wisdom, the informed retailer should not hide information from

the supplier to prevent leakage. Third, we show that there exist many combinations of wholesale

price and revenue share percentage under which the supplier will not leak information. Preventing

information leakage may result in higher prots for both the incumbent and supplier relative to a

scenario where the supplier leaks information and, interestingly, even the entrant may be better o

sometimes. Fourth, our results also suggest that a revenue share percentage that is neither too low

nor too high is more capable of preventing leakage. This middle range is consistent with studios

revenue share percentages (40-60%) in the video rental industry as well as their share of revenues

with movie theaters (Dana and Spier 2001). In this scenario, the supplier may even be able to choose

a wholesale price that maximizes her prots while preferring not to leak information. Thus, we

have established that a revenue sharing contract can be robust in its ability to prevent information

leakage. Fifth, as the range of potential demand values (high versus low) increases, nonleakage

becomes more likely, i.e. the possible set of wholesale prices and revenue share combinations for

which nonleakage is an equilibrium expands. In such a scenario, the potential quantity distortion

is more severe and hence the supplier leans toward nonleakage more willingly.

ReferencesAnand, K. S. and M. Goyal. 2009. Strategic information management under leakage in a supply

chain. Management Science 55(3) 438452.

Cachon, G., M. Lariviere. 2005. Supply shain coordination with revenue-sharing contracts:

4strengths and limitations. Management Science 51(1) 3044.

Dana, J. D., Jr., K. E. Spier. 2001. Revenue sharing and vertical control in the video rental

industry. Journal of Industrial Economics Vol. XLIX, 3 224245.

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