Mechanism Design for Capacity Allocation with Price Competition Masabumi Furuhata Intelligent Systems Laboratory University of Western Sydney, Australia and IRIT-Université de Toulouse, France mfuruhat@scm.uws.edu.au Laurent Perrussel IRIT-Université de Toulouse, France laurent.perrussel@univ- tlse1.fr Dongmo Zhang Intelligent Systems Laboratory University of Western Sydney, Australia dongmo@scm.uws.edu.au ABSTRACT Studies on mechanism design mostly focus on a single mar- ket where sellers and buyers trade. This paper examines the problem of mechanism design for capacity allocation in two connected markets where a supplier allocates products to a set of retailers and the retailers resale the products to end-users in price competition. We consider the problems of how allocation mechanisms in the upstream market de- termine the behaviors of markets in the downstream market and how pricing policy in the downstream market influences the properties of allocation mechanisms. We classify an ef- fective range of capacity that influences pricing strategies in the downstream market according to allocated quantities. Within the effective capacity range, we show that the re- tailers tend to inflate orders under proportional allocation, but submit truthful orders under uniform allocation. We ob- serve that heterogeneous allocations results in greater total retailer profit which is a unique phenomenon in our model. The results would be applied to the design and analysis of Business-to-Business (B2B) marketplaces and supply chain management. Categories and Subject Descriptors K.4.4 [Computers and Society]: Electronic Commerce; I.2.1 [Artificial Intelligence]: Applications and Expert Systems—Games General Terms Design, Economics, Management Keywords Allocation mechanism design, supply chain management, oligopoly Permission to make digital or hard copies of all or part of this work for personal or classroom use is granted without fee provided that copies are not made or distributed for profit or commercial advantage and that copies bear this notice and the full citation on the first page. To copy otherwise, to republish, to post on servers or to redistribute to lists, requires prior specific permission and/or a fee. 10th Int. Conf. on Electronic Commerce (ICEC) ’08 Innsbruck, Austria Copyright 2008 ACM 978-1-60558-075-3/08/08 ...$5.00. 1. INTRODUCTION Mechanism design (MD) has been one of the most promis- ing research topics in the fields of e-business and artificial intelligence in recent years [8, 26, 22, 13]. The main concern of MD is to induce truthful preferences from self-interested agents. Studies on MD mostly focus on a single market where sellers and buyers trade. However, in many situations, traders’ preferences are restricted to market situations. If the traders are located in a supply chain, the information about the traders’ preferences can then be partially deduced from the analysis of the market situations. Particularly, it is interesting to show how such information could be applied to mechanism design. In this paper we explore the problem in the context of capacity allocation mechanisms. Consider a supply chain where a supplier sells products to a set of retailers. Suppose all orders from the retailers exceed the capacity of the supplier. To solve unbalance of supply and demand, allocation instead of an adjustment by price is commonly observed in many supply chains. This is particu- lar in the upper stream of supply chains such as component, raw material and natural resource markets. The reasons that allocation is favored in the upstream is changing price are time consuming and costly for the customers. A change of price of raw material involves the product cost controlling of the customers and, in the worst case, the customer must go back to a product design phase. In fact, a long-term price contract is common and a spot price contract is ob- served for a small amount of trades in such markets. Hence, the price adjustment is not always proper method. When a commodity supplier determines to allocate products, a num- ber of working staffs in a sales and operations department ask customers about the truthful demand. This activity is very common in industry and a typical procedure when the supplier employs proportional allocation mechanism which is the most popular mechanism. We show a reason why this procedure is required under the mechanism. Furthermore, we present how to induce truthful orders from the retailers by an allocation mechanism. There are two reasons for us to choose the subject. First, capacity allocation is one of the most important issues in computing-related applications, such as resource allocation [9, 1, 15], task allocation [17, 23]. Moreover, capacity alloca- tion deals with the problem of scarce resources. A small change of allocation in the upstream market would affect the downstream markets significantly. Therefore the design Permission to make digital or hard copies of all or part of this work for personal or classroom use is granted without fee provided that copies are not made or distributed for profit or commercial advantage and that copies bear this notice and the full citation on the first page. To copy otherwise, or republish, to post on servers or to redistribute to lists, requires prior specific permission and/or a fee. 10th Int. Conf. on Electronic Commerce (ICEC) ’08 Innsbruck, Austria Copyright 2008 ACM 978-1-60558-075-3/08/08 ...$5.00.