Contracting and Coordination under Asymmetric Production Cost Information

We analyze a supply chain consisting of a supplier and a retailer. The supplier's unit production cost, which characterizes his type, is only privately known to him. When trading with the retailer, the supplier demands a reservation profit that depends on his unit production cost. We model this problem as a game of adverse selection. In this model, the retailer offers a menu of contracts, each of which consists of two parameters: the ordering quantity and the supplier's share of the channel profit. We show that the optimal contract depends critically on a surrogate measure—the ratio of the types’ reservation profit differential to their production cost differential. An important implication from our analysis is that information asymmetry alone does not necessarily induce loss in channel efficiency. The optimal contract can coordinate the supply chain as long as the low‐cost supplier's cost efficiency is neither much overvalued nor much undervalued in the outside market. We further discuss the retailer's preference of the supplier's type under different market conditions, as well as evaluate the effects of the supplier's reservation profit, the retail price, and the demand uncertainty on the optimal contract.     

Supply Chain Coordination in the Presence of Gray Markets and Strategic Consumers

The practice of diverting genuine products to unauthorized gray markets continues to challenge companies in various industries and creates intense competition for authorized channels. Recent industry surveys report that the abuse of channel incentives is a primary reason for the growth of gray market activities. Therefore, it is crucial that companies take the presence of gray markets into consideration when they design contracts to distribute products through authorized retailers. This issue has received little attention in the extensive literature on contracting and supply chain coordination. In this study, we analyze the impacts of gray markets on two classic contracts, wholesale price and quantity discount, in a supply chain with one manufacturer and one retailer when the retailer has the opportunity to sell to a domestic gray market. Our analysis provides interesting and counterintuitive results. First, a classic quantity‐discount contract that normally coordinates the supply chain can perform so poorly in the presence of a gray market that the supply chain would be better off using a wholesale price contract instead. Second, the presence of gray market can also degrade the performance of the wholesale price contract; therefore, a more sophisticated contract is needed for coordinating the supply chain. We show that contracts that solely depend on retailer's order quantity cannot coordinate the supply chain, and provide the conditions for coordinating the supply chain with price‐dependent quantity discount contracts. We also provide comparative statics and show that when there is a gray market, coordinating the supply chain enhances total consumer welfare.     

Technical Note—Demand Uncertainty Reduction in Decentralized Supply Chains

This note analyzes the effects associated with reducing demand uncertainty in a decentralized supply chain comprising one manufacturer, one retailer, and a wholesale price contract that governs the transactions between them. The demand uncertainty level is parameterized through a mean‐preserving spread, and the manufacturer's and the retailer's equilibrium decisions are solved accordingly. We consider the case of an exogenous retail price as well as the case of an endogenous retail price, and we find in both cases that the manufacturer's and the retailer's expected profits in equilibrium are not necessarily monotone decreasing in the uncertainty level. Thus, we find that, even if the cost of reducing demand uncertainty is zero, uncertainty reduction can hurt rather than benefit either or both members of the supply chain.     

Optimal Contract Design for Mixed Channels Under Information Asymmetry

The mixed‐channel model is becoming increasingly popular in the marketplace. In this model, a firm selling through the traditional supply chain of wholesaler and retailer opens a direct channel to the customer through Internet sales. Because both channels have their respective advantages, the manufacturer is attracted to this business model. However, it also leads to channel conflict, with the retailer feeling threatened by direct competition. One way of eliminating the possibility of this channel conflict, where the retailer is allowed to add value to the product to differentiate its offering to the customers, is proposed in this paper. The retailer is also given full authority to make pricing decisions. This paper presents a model, under this scenario, of obtaining optimum pricing decisions by both parties, the amount of value added by the retailer, and the manufacturer's wholesale price to the retailer. Our model incorporates information asymmetry, where the manufacturer has incomplete information about the retailer's cost of adding value. We obtain closed‐form contracts with incomplete information and compare them with those with complete channel coordination. We also develop a number of managerial guidelines and identify future research topics.     

Complexity as a Contract Design Factor: A Human‐to‐Human Experimental Study

Despite being theoretically suboptimal, simpler contracts (such as price‐only contracts and quantity discount contracts with limited number of price blocks) are commonly preferred in practice. Thus, exploring the tension between theory and practice regarding complexity and performance in contract design is especially relevant. Using human subject experiments, Kalkancı et al. (2011) showed that such simpler contracts perform effectively for a supplier interacting with a computerized buyer under asymmetric demand information. We use a similar set of experiments with the modification that a human supplier interacts with a human buyer. We show that human interactions strengthen the supplier's preference for simpler contracts. We find that suppliers have fairness concerns even when they interact with computerized buyers. These fairness concerns tend to be even stronger when suppliers interact with human buyers, particularly when the complexity of the contract is low. We also find that suppliers are more prone to random decision errors (i.e., bounded rationality) when interacting with human buyers. In the absence of social preferences, Kalkancı et al. identified reinforcement and bounded rationality as key biases that impact suppliers' decisions. In human‐to‐human experiments, we find evidence for social preference effects. However, these effects may be secondary to bounded rationality.     

Supply Contract Design for Competing Heterogeneous Suppliers under Asymmetric Information

This study considers a supply chain with two heterogeneous suppliers and a common retailer whose type is either low‐volume or high‐volume. The retailer's type is unknown to the suppliers. The flexible supplier has a high variable cost and a low fixed cost, while the efficient supplier has a low variable cost and a high fixed cost. Each supplier offers the retailer a menu of contracts. The retailer chooses the contract that maximizes its expected profit. For this setting, we characterize the equilibrium contract menus offered by the suppliers to the retailer. We find that the equilibrium contract menus depend on which supplier–retailer match can generate the highest supply chain profit and on how much information rent the supplier may need to pay. An important feature of the equilibrium contract menus is that the contract assigned to the more profitable retailer will coordinate the supply chain, while the contract assigned to the less profitable retailer may not. In addition, in some circumstances, the flexible supplier may choose not to serve the high‐volume retailer, in order to avoid excessive information rent.     

Pricing Policy in a Supply Chain: Negotiation or Posted Pricing

This article examines the choice of pricing policy (posted pricing or negotiation) toward end customers in a supply chain. Many retailers actively decide whether or not to encourage negotiation on the shop floor. Of course, the retailer's pricing policy influences not only the retailer's profit, but also the profits of the manufacturers who sell through the retailer. However, little is known about the forces that shape the pricing policy when two self‐interested parties interact in a supply chain. We consider two alternative models depending on who has the power to decide the pricing policy: the manufacturer or the retailer. We find that an increase in the wholesale price weakens the retailer's ability to price discriminate through negotiation. Therefore, the retailer prefers negotiation at lower wholesale prices and posted pricing at higher wholesale prices. We also find that whenever the retailer prefers negotiation, the manufacturer does too. Therefore, the retailer's discretion over the pricing policy causes friction only when the retailer wants to use posted pricing, while the manufacturer wishes the retailer to use negotiation. We show that such friction arises only when product availability or the cost of negotiation is moderate. In this case, we show that the manufacturer may offer a substantial discount to persuade the retailer to negotiate. Surprisingly, in this region of friction, a decrease in the supply chain's capacity or an increase in negotiation costs (both of which are typically considered as worsening the retailer's business environment) translates into higher profit for the retailer.     

Mechanisms to Induce Buyer Forecasting: Do Suppliers Always Benefit from Better Forecasting?

In this study, we consider a supplier's contract offerings to a buyer who may obtain improved forecasts for her demand over time. We investigate how the supplier can take advantage of the buyer's better forecasts and what kind of contracts he should offer to the buyer in order to maximize his profits. We model a natural forecast evolution where the buyer can obtain a more accurate forecast closer to the selling season. We assume there is information asymmetry between the buyer and the supplier at all times in that the buyer understands her demand better than the supplier. Three types of contracts that the supplier can offer are considered: (1) one where a contract is offered before the buyer has a chance to obtain improved forecasts, (2) one where a contract is offered after the buyer has obtained improved forecasts, and (3) a contingent (dynamic) contract which offers an initial contract to the buyer before she obtains improved forecasts, followed by a later contract (contingent on the initial contract) offered after improved forecasts have been obtained. We consider two scenarios: (1) where the supplier is certain that the buyer can obtain more accurate forecasts over time, and (2) where the supplier is uncertain about the buyer's forecasting capability (or forecasting cost). In the first scenario, we show that among the three types of contracts, the contingent contract is always the most profitable for the supplier. Furthermore, using the contingent contract, the supplier always benefits from higher accuracy of the buyer's demand forecasts. In the second scenario, we explicitly model the supplier's level of certainty about the buyer's capability of obtaining better forecasts, and explore how the supplier can design contracts to induce the buyer to obtain better forecasts when she is capable.     

Motivating Retail Marketing Effort: Optimal Contract Design

We study a distribution channel where a manufacturer relies on a sales agent for selling the product, and for investing in the most appropriate marketing effort. The agent's effort is hard to monitor. In addition, the cost of effort is the agent's private information. These impose challenges to the manufacturer in its endeavor to influence the agent's marketing effort provisions and to allocate profit between the two parties. We propose two contract forms. The franchise fee contract is a two‐part price schedule specifying a variable wholesale price and a fixed franchise fee. The retail price maintenance contract links the allowed retail price that the agent charges customers with total payment to the manufacturer and sales level. Under information asymmetry, for implementing either contract form, the manufacturer needs to offer a menu of contracts, hoping to invoke the “revelation principle” when the agent picks a certain contract from that menu. We show that the two contract forms perform differently, and each party's preference toward a particular contract form is linked with the total reservation profit level and/or the sales agent's cost type. We provide managerial guidelines for the manufacturer in selecting a better contract form under different conditions.     

Push and Pull Contracts in a Local Supply Chain with an Outside Market*

Wholesale price contracts are widely studied in a single supplier‐single retailer supply chain, but without considering an outside market where the supplier may sell if he gets a high enough price and the retailer may buy if the price is low enough. We fill this gap in the literature by studying push and pull contracts in a local supplier–retailer supply chain with the presence of an outside market. Taking the local supplier's maximum production capacity and the outside market barriers into account, we identify the Pareto set of the push and/or pull contracts and draw managerial implications. The main results include the following. First, the most inefficient point of the pull Pareto set cannot always be removed by considering both the push and pull contracts. Second, the supplier's production capacity plays a significant role in the presence of an outside market; it affects the supplier's negotiating power with the retailer and the coordination of the supply chain can be accomplished only with a large enough capacity. Third, the import and export barriers influence the supply chain significantly: (i) an export barrier in the local market and the supplier's production capacity influence the supplier's export strategy; (ii) a low import (resp., export) barrier in the local market can improve the local supply chain's efficiency by use of a push (resp., pull) contract; and (iii) a high import (resp., export) barrier in the local market encourages the supplier (resp., retailer) to bear more inventory risk.     

When Does a Retailer's Advance Selling Capability Benefit Manufacturer,Retailer, or Both?

Advance selling (AS) from a retailer to consumers is commonly observed in practice. With an AS capability, a retailer has the option to sell in advance or not. Having the AS option seems to increase flexibility and thus profit for a retailer. However, we show that the AS option can hurt the retailer's profit as well as supply chain performance. We identify two thresholds for a product's marginal production cost. A retailer's AS option benefits both the manufacturer and retailer when the marginal production cost is high, that is, above both thresholds. It benefits the manufacturer but hurts the retailer when the marginal production cost is moderate, that is, between the two thresholds. The result is ambiguous when the marginal production cost is low, that is, below both thresholds. We find that consumer valuation uncertainty under AS is the key driving force for the surprising result that having the retailer's AS option can hurt the retailer. When compared to the scenario where the retailer does not have the AS option, we find that the manufacturer's optimal wholesale price weakly decreases under the retailer's AS option if the marginal production cost is high. The statement is reversed if the marginal production cost is moderate or low.     

Coordinating contracts for a financially constrained supply chain

We consider a financially constrained supply chain in which a supplier (leader) sells products to a retailer (follower) who has no access to bank financing due to her low credit rating. However, the supplier can borrow from a bank and offer trade credit to the retailer to alleviate her financial constraint. Failure to pay off a bank loan or trade credit incurs a variable default cost. We analyze the centralized version of the supply chain to obtain new coordination requirements. We then examine whether revenue-sharing, buyback, and all-unit quantity discount contracts can coordinate our supply chain. We show that the all-unit quantity discount contract fails to coordinate. However, the revenue-sharing and buyback contracts can coordinate the supply chain, but only when the supply chain has a sufficient total working capital. Moreover, they cannot allocate profit flexibly unless the supplier has a large enough working capital. Finally, we design a generalized revenue-sharing contract that coordinates the supply chain with flexible profit allocation, and also show by numerical examples its superiority over the revenue-sharing and buyback contracts.     

Mean-risk analysis of radio frequency identification technology in supply chain with inventory misplacement: Risk-sharing and coordination

This paper investigates the application of radio frequency identification (RFID) technology to eliminate the misplacement problems in the supply chain, which consists of a risk-neutral manufacturer and a risk-averse retailer. By considering both fixed cost and tag cost of RFID implementation, we study the agents' incentives to adopt RFID in both uncoordinated and coordinated cases. We focus on analyzing the impact of risk attitudes on the agents’ incentives and on the supply chain coordination. The central semi-deviation is adopted to measure the retailer's risk attitude. In the uncoordinated case, we find that, in order to induce the retailer to adopt RFID, the manufacturer must assume more fixed cost if the retailer is more risk-averse. In the coordinated case, we first show that the standard revenue sharing contract does not always coordinate the channel. If the channel is coordinated, we observe that the agents’ incentives will be perfectly aligned and independent of the risk attitudes, if the revenue sharing ratio equals the fixed cost sharing ratio. Then we propose a risk-sharing contract that offers the risk protection to the retailer, to achieve the channel coordination. An interesting finding is that the manufacturer's incentive will not decrease with the tag cost, if she takes much risk from the retailer. The corresponding impacts of RFID adoption on the two contracts are also analyzed in this paper. Finally, a case study in a tobacco industry is presented to show the real RFID cost in practice.     

Coordinating Supply Chains via Advance‐Order Discounts,Minimum Order Quantities,and Delegations

To avoid inventory risks, manufacturers often place rush orders with suppliers only after they receive firm orders from their customers (retailers). Rush orders are costly to both parties because the supplier incurs higher production costs. We consider a situation where the supplier's production cost is reduced if the manufacturer can place some of its order in advance. In addition to the rush order contract with a pre‐established price, we examine whether the supplier should offer advance‐order discounts to encourage the manufacturer to place a portion of its order in advance, even though the manufacturer incurs some inventory risk. While the advance‐order discount contract is Pareto‐improving, our analysis shows that the discount contract cannot coordinate the supply chain. However, if the supplier imposes a pre‐specified minimum order quantity requirement as a qualifier for the manufacturer to receive the advance‐order discount, then such a combined contract can coordinate the supply chain. Furthermore, the combined contract enables the supplier to attain the first‐best solution. We also explore a delegation contract that either party could propose. Under this contract, the manufacturer delegates the ordering and salvaging activities to the supplier in return for a discounted price on all units procured. We find the delegation contract coordinates the supply chain and is Pareto‐improving. We extend our analysis to a setting where the suppliers capacity is limited for advance production but unlimited for rush orders. Our structural results obtained for the one‐supplier‐one‐manufacturer case continue to hold when we have two manufacturers.     

Impacts of demand uncertainty on retailer's dominance and manufacturer-retailer supply chain cooperation

Recent studies in marketing and distribution channels have shown that the balance of power between manufacturers and retailers is shifting. Based on this observation, we investigate a two-echelon supply chain with a manufacturer and a retailer in this paper. We first develop retailer-dominant non-cooperative game models by introducing a sensitivity of retailer's order quantity to manufacturer's wholesale price; then we analyze two cooperative scenarios, in which the Nash bargaining model is utilized to implement profit sharing between the manufacturer and the retailer. Under the assumption that the manufacturer and the retailer are risk-neutral, we find that the manufacturer and the retailer can bargain to cooperate at any level of retail-market demand uncertainty with exogenous retail price. However, the cooperation is conditional on retail-market demand uncertainty with endogenous retail price: it can be implemented if the fluctuation of retail-market demand is relatively small, and the measure of retail-market demand uncertainty does not exceed an upper bound. Theoretical and numerical analyses show that the retailer's dominance over the manufacturer increases with the increase in the sensitivity of retailer's order quantity to manufacturer's wholesale price under a limitation of retail-market demand uncertainty. Numerical analyses also show that the retailer's dominance decreases with the increase in retail-market demand uncertainty.     

Contract Length as Risk Management When Labor is not Homogeneous

This paper examines the choice of contract length for workers who possess unique skills. Uncertainty, facing both the worker and the firm, creates an incentive to reallocate risk. The uncertainty arises from two sources: variation in the market value of the worker's human capital and fluctuation in the worker's physical production. Long‐term contracts are typically modeled as compensating wage differentials, or as a solution to the problem of asymmetric information. This paper develops a model proposing more complex behavior in the reallocation of risk between the contracting parties. The model shows that long‐term labor contracts are most likely to be observed when price uncertainty in the labor market exceeds the worker's productive uncertainty.     

Pay‐Back‐Revenue‐Sharing Contract in Coordinating Supply Chains with Random Yield

We consider coordination issues in supply chains where supplier's production process is subject to random yield losses. For a simple supply chain with a single supplier and retailer facing deterministic demand, a pay back contract which has the retailer paying a discount price for the supplier's excess units can provide the right incentive for the supplier to increase his production size and achieve coordination. Building upon this result, we consider coordination issues for two other supply chains: one with competing retailers, the other with stochastic demand. When retailers compete for both demand and supply, they tend to over‐order. We show that a combination of a pay back and revenue sharing mechanism can coordinate the supply chain, with the pay back mechanism correcting the supplier's under‐producing problem and the revenue sharing mechanism correcting the retailers' over‐ordering problem. When demand is stochastic, we consider a modified pay‐back‐revenue‐sharing contract under which the retailer agrees to not only purchase the supplier's excess output (beyond the retailer's order), but also share with the supplier a portion of the revenue made from the sales of the excess output. We show that this contract, by giving the supplier additional incentives in the form of revenue share, can achieve coordination.     

Procurement with Reverse Auction and Flexible Noncompetitive Contracts

This article investigates a hybrid procurement mechanism that combines a reverse auction with flexible noncompetitive contracts. A buyer adopts such mechanism to procure multiple units of a product from a group of potential suppliers. Specifically, the buyer first offers contracts to some suppliers who, if accepting the contract, do not participate in the auction while committing to selling a unit to the buyer at the price of the subsequent auction. For the suppliers rejecting the offers, they can join the subsequent auction with the other suppliers to compete on the remaining units. When the buyer offers only one flexible noncompetitive contract, we find that the selected supplier may accept the offer regardless of whether he knows his exact cost information. Meanwhile, the buyer can benefit from offering such a contract, as opposed to solely conducting a regular reverse auction or offering a noncompetitive contract that does not allow suppliers declining offers to join the subsequent auction. Moreover, we find that the suppliers' information about their own costs has a significant impact on the buyer's decision. When the buyer makes multiple offers, we analyze the resulting game behavior of the selected suppliers and demonstrate that the buyer can benefit more than just offering one such contract. Therefore, the hybrid procurement mechanism can be mutually beneficial for both the buyer and the selected suppliers.     

Quantity Flexibility Contract in the Presence of Discount Incentive

We design a new contract, which we refer to as the QFi contract, that combines the quantity flexibility (QF) mechanism and the price‐only discount incentive. Under the QF contract, the buyer does not assume full responsibility for the forecast, yet the supplier guarantees the availability of the forecasted quantity and extra buffer inventory. In contrast, the price‐only discount contract places full inventory burden on the buyer. We show that the proposed QFi contract effectively balances the inventory risk for both the buyer and the supplier considering both the QF and discount mechanisms. We also show that the QFi contract is able to achieve supply chain coordination. More importantly, the QFi contract's coordinating price scheme does not require knowledge of demand distribution. We identify areas where the buyer and supplier may both benefit from implementing the QFi contract as opposed to the extant QF or price‐only (wholesale) discount contractual decisions in a decentralized supply chain. We also specify the conditions under which supply chain coordination can be achieved in a win‐win manner. We conclude with managerial implications and provide directions for future research.     

具有两阶段生产模式和需求信息更新的供应链契约研究

针对二级供应链,在基于Stackelberg博弈的批发价契约中,分析了折扣价格与零售商最优提前订购量的关系及对契约双方期望收益的影响;设计了价格折扣与回购联合的协调契约,分析了供应链系统的最优提前生产量、供应链协调条件及协调契约下制造商和零售商的期望收益变化,并在协调契约不满足制造商的个体理性约束时,提出采用不对称Nash谈判模型设计两阶段生产与订购的回购契约,在保证供应链系统整体绩效最优的条件下,使制造商和零售商利润都能得到满意增长。研究表明,三级供应链实行两阶段订购的必要条件是分销商与零售商的最优提前订购量相等,与二级供应链相比,价格折扣契约下三级供应链效率更低,但价格折扣与回购联合的契约同样能协调三级供应链,该协调契约满足零售商与分销商激励相容约束。