Sharing Is Caring. And Profitable.

Despite general consensus against the practice, many retail companies are sharing weekly – even daily – sales information with their suppliers. Are they crazy?

August 14, 2014

Secrets are a kind of currency. Few people know the formula for Coca-Cola, the algorithm that drives Google searches, or the precise logistics behind an Amazon delivery. Firms pull value — they derive competitive advantage — from well-guarded knowledge.

This in mind, researchers have consistently pointed out that retailers should be wary of opening their books to suppliers. For example, if U.S. automotive vendors shared demand and sales figures with the Big Three auto manufacturers, then these manufacturers could turn around and use the information to squeeze vendor margins.

And yet, in practice, retailers have become increasingly willing to share their information with suppliers. According to the Grocery Manufacturers Association, most U.S. grocery retailers and merchandisers with more than $5 billion in annual sales are sharing weekly, even daily, store sales (among other data) directly with their suppliers. And they are doing this at no cost to the supplier.

The big, troubling question: why are they doing this?

Jiwoong Shin of Yale University worked with Brian Mittendorf of Ohio State University and Dae-Hee Yoon of Yonsei University to find a reason for this striking gap between research and practice. Publishing an article in Quantitative Marketing and Economics, they suggest that when retailers open their books, manufacturers are more inclined, and more able, to invest resources in building consumer demand.

“Information sharing as a means to coax additional manufacturer investment implies that information sharing (by the retailer) and investment (by the manufacturer) represent a mutually-beneficial tit-for-tat relationship that arises naturally,” they write.

To show this, the authors designed a straightforward model in which a manufacturer produces a product and sells it to a retailer (who sells it to customers). In the model, retailers first had to decide whether or not to establish an information-sharing agreement with manufacturers, and then manufacturers decided their investment level for enhancing consumer demand. Next, retailers observed market demand and either did or did not share this information depending on the agreement reached. Finally, the manufacturer set a wholesale price and the retailer a retail price.

The model revealed that even the initial promise of information — the mere expectation that retail information was on the way — elicited manufacturer investment in consumer demand. (This investment comes in any number of forms, from a brand-level marketing campaign or in-store point-of-purchase display, to product modifications that target local market preferences.) Without any information sharing agreement, manufacturers are forced to both invest in advertising and set wholesale prices conservatively, as they don’t have a clear picture of prospective demand; a common result is underinvestment and inefficient pricing. The transparency of information sharing can help alleviate these manufacturer concerns.

It’s important to note that the model rests on two key assumptions: first, retailers cannot renege on the promise to share information, and what they share must be truthful. Second, the contract between a retailer and a manufacturer must be based on a simple linear pricing model, so it can’t include any complexities like bulk discounts. The model’s results — that information sharing is advantageous — are thus most relevant in industries with two properties. First, information is shared through formal technology infrastructure — a transparent and upfront investment that signals a retailer’s commitment. Second, contracts need to be sufficiently simple that manufacturers cannot use the shared information to extract every drop of profit from the retail end. Car dealerships, clothing shops, and grocery stores fit nicely as examples of this type of market.

As barriers to information sharing drop lower, the conventional wisdom that company-specific knowledge should be held close deserves a second look. Of course, some secrets will always be necessary: Walmart wouldn’t last long if it shared every operational detail with suppliers. But for certain markets, too much opacity, it’s clear, will ultimately damage the bottom line.

Contributed by:
Dylan Walsh
Freelance journalist, New Haven, CT
 

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