Channel management for basic products and ancillary services

We study a supply chain where a supplier, such as an original equipment manufacturer (OEM), sells a basic product and an ancillary service through a retailer. Random demands for both product and service can be in uenced by costly sales efforts by the retailer. If the service attachment is sales effort independent, it is possible that a price-only contract selling the basic product at margin and charging back from the service product can coordinate the supply chain, due to the complementary effect between the basic product and its ancillary service and the inventory-riskless feature of the service product. For the general case, we develop a coordinating scheme of giving up all service margin and offering a quantity discount schedule for the basic product that can arbitrarily share the benefits of coordination. We further provide an alternative coordination scheme that can be implemented over existing wholesale prices for the product and service. This alternative scheme provides discounts to the retailer when her order quantity for the product and the attach rate for the service exceed respective thresholds. We show that in the absence of coordination, supply chain profits are higher if the retailer instead of the supplier provides the service assuming both have the same cost structure. We also show that a win-win mechanism can coordinate the system in the important case where the retailer provides the service but the supplier has a cost advantage on spare parts.