Supply Chain Coordination and Contracts

Abstract

This note addresses the dynamics of supply chains as they affect profits--how profits may be both maximized overall and equitably distributed across the supply chain. Influences of pricing and stocking are discussed, as are the benefits and shortcomings of coordination by the most common types of contract.

Excerpt

UVA-OM-1442

Rev. Oct. 26, 2011

Supply Chain Coordination AND COntracts

Introduction

In this note, we discuss the importance of coordination in a supply chain. When different parties in the supply chain operate in their own best interest, without considering the rest of the supply chain, the overall supply chain profits may be much worse than if supply chain decisions were coordinated. This is due to the fact that the decisions that maximize one party's profit do not necessarily maximize the overall supply chain profit. This phenomenon is known as double marginalization.

In a supply chain, an upstream company sells goods to a downstream company, which then sells them to customers. When either company can influence the level of customer demand through its actions, this will have an impact on the quantity sold by both companies and hence on the profits of both. We will show that when acting independently, companies will usually adopt a policy of higher prices and lower volumes in the supply chain than would be optimal for the supply chain as a whole.

. . .

Keywords: double marginalization, order quantity, wholesale pricing contract, [RETURN]buyback contract, revenue-sharing contract, profit-sharing contract