Double marginalization is the phenomenon in which different firms in the same industry that have their respective market powers but at different vertical levels in the supply chain (upstream and downstream) apply their own markups in prices.
Due to these markups individually a deadweight loss happens and because of both the markups the deadweight loss occurs twice thus making it worse off for the whole market due to double marginalization.
This is due to the fact that vertically integrated supply chains are often inflexible in terms of responding to the diverse stakeholder dynamics that are reshaping the ways in which organizations buy and sell in the emerging global economy.
It is concluded that a centralized supply chain may perform strictly worse than a decentralized supply chain when customers are strategic in their buying patterns. While the references were mostly focused on retail sector customers, it is not unreasonable to conclude that this buying pattern can to varying degrees be extended to all industries as a result of the increasing scrutiny of purchasing practices within both private and public sector organizations.
The problem with double marginalization arises when more than one firm in the supply chain faces a downward sloping demand curve and has the incentive to mark-up the product’s price.
A downward sloping demand curve occurs when a buyer must expend time and effort to discover prices or the characteristics of the product. As a result once the buyer has picked a seller they will stay with that supplier as long as they find the exchange satisfactory. It is the prospect of a lengthy research process that stops buyer willingness to look elsewhere while simultaneously fueling supplier motivation to increase price.
As a result when multiple firms within a particular supply chain are in this position, the sequence of mark-ups leads to a higher selling price and a lower combined profit for the supply chain.
In the decentralized supply chain, the research expenditure time on the part of the buyer is dramatically reduced. As a result not only is the responsibility on the part of the supplier to increase prices kept in check, the threat of stock-outs is virtually eliminated as a result of the buyer’s ability to reliably engage a broader supply base.
Never before has the buyer had at their disposal the tools that equip them with critical intelligence on a real-time basis. This in turn creates both visibility and efficiency throughout the entire supply network. The end result is better prices for the buyer while still maintaining a fair and equitable level of profitability for the seller.
This of course eliminates a variety of problems including supply base erosion, myopic or narrowly defined costing practices, and diminishing end-customer service levels.
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