Vertically restrictive pricing in supply chains with price‐dependent demand

We examine the behavior of a manufacturer and a retailer in a decentralized supply chain under price‐dependent, stochastic demand. We model a retail fixed markup (RFM) policy, which can arise as a form of vertically restrictive pricing in a supply chain, and we examine its effect on supply chain performance. We prove the existence of the optimal pricing and replenishment policies when demand has a linear additive form and the distribution of the uncertainty component has a nondecreasing failure rate. We numerically compare the relative performance of RFM to a price‐only contract and we find that RFM results in greater profit for the supply chain than the price‐only contract in a variety of scenarios. We find that RFM can lead to Pareto‐improving solutions where both the supplier and the retailer earn more profit than under a price‐only contract. Finally, we compare RFM to a buyback contract and explore the implications of allowing the fixed markup parameter to be endogenous to the model. © 2006 Wiley Periodicals, Inc. Naval Research Logistics, 2006.