Incentives for Transshipment in a Supply Chain with Decentralized Retailers

We examine transshipment incentives in a decentralized supply chain where a monopolist distributes a product through independent retailers. A key insight is that the transshipment price determines whether the firms benefit from, or are hurt by, transshipment. In particular, we show that the manufacturer prefers to set the transshipment price as high as possible, whereas retailers prefer a lower transshipment price. Given the important role of the transshipment price in determining the benefits that each firm gets from transshipment, it is useful to consider transshipment in the case where retailers are under joint ownership (a "chain store") and the transshipment price does not play a role. This comparison yields two surprising results. First, if decentralized retailers control the transshipment price, they will choose a relatively low transshipment price as a way to mitigate the manufacturer's ability to extract profits by increasing wholesale prices; therefore, the manufacturer may prefer dealing with the chain store, which does not have a transshipment price, rather than with decentralized retailers. Similarly, the decentralized retailers can use a low transshipment price to achieve higher total profits than a chain store.