Contract design for risk sharing partnerships in manufacturing

The development of extensive partnerships with suppliers has become a characteristic of manufacturing, particularly in the aircraft and automobile industries. This paper considers the development of appropriate contracts that enable market risks to be shared between the lead manufacturer and the partners. It is shown that it is usually appropriate to have threshold contracts, i.e., contracts where a partner only shares in profits if sales exceed a value determined by risk tolerance and target return. The value of having financial partners as well as manufacturing partners is demonstrated, although it is also shown that financial partner contributions to the project should be limited. We also consider the situation where partners have pre-existing commitments to other projects, perhaps with competitors. The producers sales may be correlated with the partners profits on pre-existing commitments so the impact on contract structure is explored. It is shown that even if a partner had preexisting commitments whose profit is positively correlated with product sales then it is often beneficial to use such a partner.     

A multi-objective approach to supply chain visibility and risk

This paper investigates the twin effects of supply chain visibility (SCV) and supply chain risk (SCR) on supply chain performance. Operationally, SCV has been linked to the capability of sharing timely and accurate information on exogenous demand, quantity and location of inventory, transport related cost, and other logistics activities throughout an entire supply chain. Similarly, SCR can be viewed as the likelihood that an adverse event has occurred during a certain epoch within a supply chain and the associated consequences of that event which affects supply chain performance. Given the multi-faceted attributes of the decision making process which involves many stages, objectives, and stakeholders, it beckons research into this aspect of the supply chain to utilize a fuzzy multi-objective decision making approach to model SCV and SCR from an operational perspective. Hence, our model incorporates the objectives of SCV maximization, SCR minimization, and cost minimization under the constraints of budget, customer demand, production capacity, and supply availability. A numerical example is used to demonstrate the applicability of the model. Our results suggest that decision makers tend to mitigate SCR first then enhance SCV.     

The risk and information sharing of application services supply chain

We study an application services supply chain consisting of one application service provider (ASP) and one application infrastructure provider (AIP). The AIP supplies the computer capacity to the ASP that in turn sells the value-added application services to the market. The market is characterized by a price-sensitive random demand. The ASP’s objective is to determine the optimal price of its service to the market and the optimal capacity to purchase from the AIP. The AIP’s goal on the other hand is to maximize its profit from selling the capacity to the ASP.     

Quality investment and price decision in a risk-averse supply chain

In this paper, we investigate quality investment and price decision of a make-to-order (MTO) supply chain with uncertain demand in international trade. Due to volatility of orders from buyers, the supplier and the manufacturer in the supply chain are subject to financial risk. In contrast to the general assumption that players in a supply chain are risk neutral in quality investment and price decision, we consider the risk-averse behavior of the players in three different supply chain strategies: Vertical Integration (VI), Manufacturer’s Stackelberg (MS) and Supplier’s Stackelberg (SS). The study shows that both supply chain strategy and risk-averse behavior have significant impacts on quality investment and pricing. Compared to a risk-neutral supply chain, a risk-averse supply chain has lower, same and higher quality of products in VI, MS and SS, respectively. Also, we derive the conditions under which the supply chain strategy is implemented in a decentralized setting. A numerical study is used to illustrate some related issues.     

The impact of partial information sharing in a two-echelon supply chain

We consider a simple two-echelon supply chain composed of a manufacturer and a retailer in which the demand process of the retailer is an AR(1) where the random component is a function of both sides’ information. We focus on partial information sharing under which each side informs the other of an interval in which the exact value of its own component of demand lies. These various levels of information sharing can reduce the supply chain costs.     

Coordination of cooperative cost-reduction efforts in a supply chain partnership

We study cooperative cost reduction in a decentralized supply chain with a single manufacturer and multiple suppliers. The manufacturer assembles components that are procured from the suppliers to produce a final product. Both the manufacturer and the suppliers invest in reducing the unit production costs of the components. We see that neither of the two well-known conventional contracts, the wholesale price contract and the cost-plus pricing contract, generally coordinates the supply chain, i.e., under both of these types of contract, the individual optimal cost-reduction efforts of players deviate from the centralized system-optimal solution. However, this result is not surprising because these contracts encourage either only the manufacturer or only the suppliers alone to invest in cost reduction.     

Mesoscopic supply chain simulation

This paper reviews and compares existing approaches for supply chain modeling and simulation and applies the mesoscopic modeling and simulation approach using the simulation software MesoSim, an own development. A simplified real-world supply chain example is modeled with discrete event, mesoscopic and system dynamics simulation. The objective of the study is to compare the process of model creation and its validity using each approach. The study examines advantages of the mesoscopic approach for the simulation. Major benefits of the mesoscopic approach are that modeling efforts are balanced with the necessary level of detail and facilitate quick and simple model creation and simulation.     

Pricing and horizontal information sharing in a supply chain with capacity constraint

This paper aims to explore manufacturers horizontal information sharing strategy under competition. The model framework is based on a two-echelon supply chain composed of one upstream supplier and two downstream manufacturers with asymmetric capacity constraint. Analysis of the model establishes manufacturers’ information sharing strategies under different conditions and shows how supplier’s pricing decision can shape manufacturers’ information sharing incentives.     

Coordination in a two-stage capacitated supply chain with multiple suppliers

The aim of this paper is to coordinate the inventory policies in a decentralized supply chain with stochastic demand by means of contracts. The system considered is a decentralized two-stage supply chain consisting of multiple independent suppliers and a manufacturer with limited production capacities. The suppliers operate on a make-to-stock basis and apply base stock policy to manage their inventories. On the other hand, the manufacturer employs a make-to-order strategy. Under the necessary assumptions, each supplier is modeled as an M/M/1 make-to-stock queue; and the manufacturer is modeled as a GI/M/1 queue after deriving an approximate distribution for the interarrival times of the manufacturer. Once the supply chain is modeled as a queuing system, centralized and decentralized models are developed. Comparison of the optimal solutions to these models reveals that the supply chain needs coordination. Three different transfer payment contracts are examined in this paper. These are the backorder and holding cost subsidy contracts, the transfer payment contract based on Pareto improvement, and the cost sharing contract. Each contract is evaluated according to its coordination ability and whether it is Pareto improving or not. The results indicate that all three contracts can coordinate the supply chain. However, when the Pareto improvement is taken into account, the cost sharing contract seems to be the one that will be preferred by all parties.     

Single-supplier/multiple-buyer supply chain coordination: Incorporating buyers’ expectations under vertical information sharing

We address the coordination problem in a single-supplier/multiple-buyer supply chain. The supplier wishes to coordinate the supply chain by offering quantity discounts. To obtain their complete cost information, the supplier exchanges his own cost parameters with buyers leading to vertical information sharing. The supplier thinks that the buyers, as they have access to supplier’s setup and holding cost information, may demand a portion of the anticipated coordination savings based on the partial information they hold about the cost structure of the entire supply chain. We model each buyer’s expectations based on her limited view of the entire supply chain which consists of herself and the supplier only. These expectations are then incorporated into the modeling of the supply chain, which results in a generalization of the traditional Stackelberg type models. We discuss alternative efficiency sharing mechanisms, and propose methods to design the associated discount schemes that take buyers’ expectations into account. In designing the discount schemes, we consider both price discriminatory and non-price discriminatory approaches. The study adds to the existing body of work by incorporating buyers’ expectations into a constrained Stackelberg structure, and by achieving coordination without forcing buyers to explicitly comply with the supplier’s replenishment period in choosing their order quantities. The numerical analysis of the coordination efficiency and allocation of the net savings of the proposed discount schemes shows that the supplier is still able to coordinate the supply chain with high efficiency levels, and retain a significant portion of the net savings.     

The use of a premium-payment scheme in a supply chain involving capacity acquisition

We study a practice whereby a downstream firm makes to his supplier a premium-payment for a certain quantity of products. We show that the adoption of this practice can induce the supplier to build bigger capacity. The higher capacity level enables the supplier to satisfy a larger portion of demands from the downstream firm, and this leads to higher payoffs for both parties in the supply chain. With the assistance of an under-capacity penalty imposed on the supplier, this premium-payment scheme can help lure the parties into taking the channel-optimal actions. Our numerical examples help reveal various features of the scheme.     

Entropy as an assessment tool of supply chain information sharing

As the order fulfillment process needs to be managed in a seamless way, the level of information sharing among the partners of the supply chain needs to be increased. An entropy-based formulation is proposed as the basis of a methodology for comparing different information sharing approaches in a supply chain environment. A step-by-step comparison of two different information sharing approaches is presented to exemplify the use of the methodology. A computer simulation is used to validate the usefulness of the proposed methodology.     

Managing the order pipeline to reduce supply chain volatility

The bullwhip effect in particular, and supply chain volatility in general, has been the subject of much analytical and empirical investigation by researchers. One goal of this work has been to determine supply chain designs and policies that minimize volatility. Using a system dynamics approach, we use three distinct supply chain volatility metrics to compare the ability of two alternative pipeline inventory management policies to respond to a demand shock. The results indicate that no one policy dominates on all three metrics of supply chain volatility. A simplistic static pipeline policy minimizes the bullwhip effect and lessens the likelihood of on-hand inventory oscillations, while a more sophisticated dynamic pipeline policy may converge more rapidly to the new equilibrium. In addition, simulation results suggest that the dynamic policy provides better customer service through fewer stockouts and backorders.     

Risk sharing and information revelation mechanism of a one-manufacturer and one-retailer supply chain facing an integrated competitor

This paper develops an information revelation mechanism model of a one-manufacturer and one-retailer supply chain facing an outside integrated-competitor under demand uncertainty. We investigate how the manufacturer designs a wholesale price-order quantity contract to induce the retailer to report his risk sensitivity information truthfully. We try to explore the effects of the outside competitor and the risk-sharing rule on the optimal price-service level decisions of the retailer and the optimal wholesale prices of the manufacturer. We find that the strategic interaction plays an important role in the effect of risk sensitivity on the order quantity for the retailer. When the fraction of the risk cost shared by the manufacturer is sufficiently large (small), the optimal wholesale price for the high risk-averse retailer is higher (lower) than that for the low risk-averse retailer.     

Long-term and penalty contracts in a two-stage supply chain with stochastic demand

Recent applications of game-theoretic analysis to supply chain efficiency have focused on constructs between a buyer (the retailer or manufacturer) and a seller (the supplier) in successive stages of a supply chain. If demand for the final product is stochastic then the supplier has an incentive to keep its capacity relatively low to avoid creating unneeded capacity. The manufacturer, on the other hand, prefers the supplier’s capacity to be high to ensure that the final demand is satisfied. The manufacturer therefore constructs a contract to induce the supplier to increase its production capacity. Most research examines contracting when final demand is realized after the manufacturer places its order to the supplier. However, if final demand is realized before the manufacturer places its order to the supplier, these types of contracts can be ineffective. This paper examines two contracts under the latter timing scenario: long-term contracts in which the business relationship is repeated, and penalty contracts in which the supplier is penalized for too little capacity. Results indicate long-term contracts increase the profit potential of the supply chain. Furthermore, the penalty contracts can ensure that the supplier chooses a capacity level such that the full profit potential is achieved.     

The effect of information sharing on supply chain stability and the bullwhip effect

This paper analyzes the bullwhip effect in multi-stage supply chains operated with linear and time-invariant inventory management policies and shared supply chain information. Such information includes past order sequences and inventory records at all supplier stages. The paper characterizes the stream of orders placed at any stage of the chain when the customer demand process is known and ergodic, and gives an exact formula for the variance of the orders placed. The paper also derives robust analytical conditions, based only on inventory management policies, to predict the presence of the bullwhip effect and bound its magnitude. These results hold independently of the customer demand. The general framework proposed in this paper allows for any inventory replenishment policies, any ways of sharing and utilizing information, and any customer demand processes. It is also shown as a special case that sharing customer demand information across the chain significantly reduces, but does not completely eliminate, the bullwhip effect.     

Coordinating order quantity decisions in the supply chain contract under random demand

In this paper, we are concerned with the coordinating quantity decision problem in a supply chain contract. The supply chain contract is composed of one manufacturer and one retailer to meet the random demand of a single product with a short lifecycle. Our analysis show that the retailer expects to obtain higher profit under proper ordering policies, which can also maximize the expected profit of the supply chain. The manufacturer may induce the retailer to order the coordinated quantity by adjusting the unit return price. As a result, the supply chain is expected to achieve the optimal expected profit.     

Transshipment incentive contracts in a multi-level supply chain

Transshipments within a supply chain can be difficult to implement as the costs and benefits are often incurred by different parties. This difficulty becomes even more problematic when the costs and benefits are not completely known by all parties. The primary purpose of this paper is to introduce the role of asymmetric information into the design of supply chain transshipment contracts. Using a representative supply chain from within the soft drink industry as an example, a multi-level contracting framework is developed that aligns incentives to encourage transshipments and improve performance in the absence of all parties having full information. Analysis of the proposed framework suggests that, even if a transshipment is likely to be unprofitable to the transshipping dyad, it may still be best for the entire supply chain. Moreover, overall supply chain inventories with transshipments do not necessarily increase relative to the no-transshipment case.     

Endogenous information acquisition in supply chain management

In this paper, we analyze an endogenous determination of efforts put into information acquisition and its impact on supply chain management. More specifically, we consider a supplier who sells a product to a buyer during a single selling season. Prior to placing an order with the supplier, the buyer has an option to acquire additional information about the demand by hiring experts (who are capable of providing forecasts). Because a commission fee must be paid to each hired expert, there exists a tradeoff between the cost and the value of the information, and the buyer needs to determine how much information to acquire. We derive the optimal information-acquisition level in an integrated setting and compare it with that determined in a decentralized setting. We also analyze several types of supply contracts to examine if they can coordinate the supply chain and allow an arbitrary division of system profit between the supplier and the buyer.     

Coordination mechanisms of supply chain systems

Supply chain management (SCM) has become an important management paradigm. As supply chain members are often separate and independent economic entities, a key issue in SCM is to develop mechanisms that can align their objectives and coordinate their activities so as to optimize system performance. In this paper, we provide a review of coordination mechanisms of supply chain systems in a framework that is based on supply chain decision structure and nature of demand. This framework highlights the behavioral aspects and information need in the coordination of a supply chain. The identification of these issues points out several directions of future research in this area.