A Profit-Sharing Mechanism for the Production-Distribution Alliance

Abstract

Important operational performance measures for a successful production-distribution alliance include not only pricing and lot-sizing policies, but also the profit sharing mechanism among members of the production-distribution alliance. This study provides a cost-based mechanism for sharing profit among members of the production-distribution alliance. The proposed mechanism share proportionally the total profit obtained from the cooperation of producer and distributor on the basis of supply costs. After formulating and solving the efficient pricing and lot-sizing algorithm to optimize the global profit for all alliance members, we illustrate the application of this mechanism using data from our previous studies. Results of the illustrated example have shown that the producer can use adequate transfer prices to support his distributors and to maximize the alliance’s profit. When the market demand quantity is price dependent, the lower transfer price leads the distributor more pricing flexibility to maximize his profit. However, the cost-based mechanism may discourage the effort of alliance’s members to improve their efficiency, since the profit is shared on the basis of one’s existing cost rather than on that of one’s operational performance.