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

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Abstract

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.

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