Fundamentals of Supply Chain Theory, 2nd Edition

Chapter 14 Supply Chain Contracts

14.1 Introduction

Supply chains are typically composed of multiple players, each with competing goals. For example, the newsvendor wants to pay a small wholesale cost per unit to the supplier, but the supplier wants a large wholesale cost. If each player acts selfishly, the resulting solution is generally suboptimal for the supply chain as a whole—the total profit earned by the supply chain is smaller than if the players could somehow bring their actions in line with one another. (By “selfishly” we don't mean they're behaving meanly or inappropriately—just that each player naturally acts in his or her own best interest, making decisions to maximize his or her own profit.)

In the past few decades, a great deal of research has studied contracting mechanisms for achieving supply chain coordination—for enticing each player to act in such a way that the total supply chain profit is maximized. The basic idea is that the players agree on a certain contract that specifies a payment, called a transfer payment, made from one party to another. The size of the transfer payment can be determined in any number of ways (and identifying these ways are the focus of much of the research). Many are quite intuitive: For example, the retailer might pay a wholesale price to the supplier but receive a credit for unsold merchandise at the end of the period (like the newsvendor's wholesale price and salvage value). If these mechanisms are designed correctly, then ...