Contract analysis: A performance measures and profit evaluation within two-echelon supply chains

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Abstract

Coordination is regarded as key in managing dependencies between distinctive members of a supply chain through the benefits of coordination mechanisms. Such coordination mechanisms are contracts, implemented to increase total supply chain profit, reduce costs and share risk among supply chain members. However, by contract implementation the retailer is constrained in his purchase by bearing the entire risk of holding the inventory (wholesale price contract) or by limited risk allocated to the supplier (buyback, revenue sharing and quantity flexibility contracts). By implementing an advanced purchase system the risk of inventory is fairly divided between the supplier and the retailer. In order to observe inventory implications on the supply chain bottom line, this article is directed towards the evaluation of performance measures and supply chain profit behavior under buyback, revenue sharing, quantity flexibility and advanced purchase discount contracts versus no coordination and wholesale price systems.

Highlights

► Investigated the performance improvement of push and hybrid contractual models. ► Verified the statement made by Cachon (2004) (exaggerated efficiency of coordination contracts). ► The behavior of profit functions and performance measures is observed.

Introduction

Managing the interdependencies among supply chain members can be a very challenging task. One solution for coordination problems involves coordination mechanisms, applied in both theory and practice. Contracts are a particular form of coordination mechanism designed to improve supply chain performance by increasing the total profit of the chain, and reducing risk by dividing the risks fairly among the members of the supply chain. The risks referred to are specific to the terms identified by the parties involved in the contract. However, current contracting literature is limited in addressing the issue of inventory management and inventory risk allocation as important supply chain considerations. While buyback, revenue sharing, and quantity flexibility seem to offer some risk allocation to the supplier, the efficiency of implementing coordination contracts has been exaggerated by the contracting literature because coordinating contracts are, according to Cachon (2004), “often compared against an inappropriate benchmark (often just a push contract).” Furthermore, in relation to the allocation of inventory risk in a supply chain, Cachon (2004) classifies coordination contracts in three broad categories:

  • Push contracts, where the retailer takes the risk of holding the inventory by placing his order before the selling season (the case of wholesale price contract).

  • Pull contracts, where the supplier takes the risk of holding the inventory by supplying the goods during the selling season as demand is observed (the case of vendor managed inventories) and

  • Advanced purchase discount contracts (APD), where the inventory risk is shared between the members: the retailer bears the risk of any purchased but unsold items, and the supplier bears the risk of unsold inventory.

This article contributes to the literature by evaluating the performance improvement of the supply chain as a whole under the applicability of different contractual terms.

The rest of the article is structured as follows. Section 2 presents the literature review in terms of push, pull, APD, and coordinating contracts, while Section 3 presents the novelty aspect of the research. The analytical model is visualized in Section 4 with a particular focus on supply chain members’ profit functions. In order to emphasize the distinctions among the cases under research, a simulation based numerical example is considered in Section 5. The final section summarizes the outcome of the research and draws general conclusions.

Section snippets

Literature review

With a groundwork in game theory and the newsvendor model, numerous contractual models have received attention from researchers. Starting from the classification of contracts as suggested by Cachon (2004) into push, pull, and APD, contracting literature can be divided into three categories according to the approach towards inventory risk allocation, as visualized in Fig. 1.

Each of these categories has its own defining characteristics as presented in the following.

Research highlights

In relation to the literature classification proposed in the previous section, a large volume of work treats individual contracts or combinations of different contracts. However, a limited body of work has been found to treat most or all contractual models by comparison (i.e. Arshinder et al., 2009a, Arshinder et al., 2009b), in the sense that comparing different types of contracts brings about the possibility of studying the implications on overall supply chain performance. For this purpose,

Analytical model

Under the consideration of a simple supply chain consisting of one supplier and one retailer facing stochastic demand, we first proceed with presenting the model description, followed by a profit function presentation of four cases: no coordination, push, various coordination contracts (buyback, revenue sharing and quantity flexibility), and APD cases as presented in Fig. 2.

Numerical example

With the scope of evaluating coordination by contracts, Arshinder et al., 2009a, Arshinder et al., 2009b proposed a framework divided into two phases: Phase I – Decision support tool (with a focus on performance measures evaluation of five different scenarios: no coordination, optimal order quantity, optimal order quantity with buyback, optimal order quantity with revenue sharing, and optimal order quantity with quantity flexibility) and Phase II – Graph theoretic model (based on diagram,

Conclusions

In order to observe the implications of different contractual models on supply chain performance, this article evaluated the performance measures and profit behavior of (1) buyback, revenue sharing, quantity flexibility, and APD contracts in relation to the results obtained under the decentralized supply chain and pure push systems (wholesale price setting) and (2) buyback, revenue sharing, and quantity flexibility in relation to APD contracts. In this respect we defined an analytical model

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    This manuscript was processed by Area Editor Mohamad Y. Jaber.

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