Item-Level RFID in a Retail Supply Chain With Stock-Out-Based Substitution

In this paper, we present a model to help evaluate the impact of an introduction of item-level radio-frequency identification (RFID) in a retail environment where stock-out-based substitution is common. There are two main thrust areas in this work. First, we examine the impact of RFID in a centralized setting where retailer and manufacturer are one entity. This thrust area is concerned with evaluating the profitability of RFID and exploring which product properties favor an RFID implementation. Second, we examine the impact of RFID in a decentralized setting, where retailer and manufacturer independently maximize their profits. We investigate the problem of sharing the costs of RFID, from both the perspective of tag costs and fixed costs. Our research shows that the presence of substitution at the shelf plays a major role in determining the expected benefits of an RFID implementation, as well as in determining the optimal allocation of these benefits among retailer and manufacturer. It is therefore critically important that decision makers make strong efforts to correctly account for subsitution effects when evaluating potential item-level RFID implementations in the retail sector.