1. ¹City University of Hong Kong, Kowloon, Hong Kong
2. ²University of Maryland, MD, USA

Correspondence: WK Chiang, Department of Management Sciences, City University of Hong Kong, Kowloon, Hong Kong

Received April 2008; Accepted August 2009; Published online 28 October 2009.

Abstract

Drop-shipping is an arrangement whereby an e-tailer, who does not hold inventories, processes orders and requests a manufacturer to ship products directly to the end customers. To explore the economic benefits of adopting drop-shipping distribution strategy in a competitive environment, we investigate the profitability and the efficiency of the drop-shipping channel as compared to the traditional channel. Specifically, we develop Economic Order Quantity (EOQ) games with pricing and lot-sizing decisions to examine the strategic interactions between a manufacturer and its retailer/e-tailer in the traditional/drop-shipping distribution channels. We identify conditions under which the drop-shipping channel profitably outperforms the traditional one. It is found that the economic interests of adopting drop-shipping distribution for the channel members may not always be consistent. There are cases where only the manufacture would favour drop-shipping. In this study, we also reveal that the inefficiency caused by lack of coordination in the traditional channel can be alleviated in the drop-shipping channel where the lot-sizing decision is made by the manufacturer.