Supply Chain Coordination through Contracts PDF

Supply Chain Coordination through Contracts Prof. Suresh K Jakhar Indian Institute of Management Lucknow  Contract  Contract is an agreement that legally binds two parties. Manufacturer and retailer in our case.  However, the role of SC contract between two SC partners goes...

Supply Chain Coordination through Contracts Prof. Suresh K Jakhar Indian Institute of Management Lucknow  Contract  Contract is an agreement that legally binds two parties. Manufacturer and retailer in our case.  However, the role of SC contract between two SC partners goes beyond the terms and conditions of business.  Contract specify who will bear how much of risk and also explicitly define the pay-offs for the parties.  Contract: Purpose  With the agreed upon risk and incentive as per contract, SC entities take their local optimization decision in decentralized setting.  They determine whether the incentives of other organizations in the supply chain are aligned with it.  If a contract is not designed well, the objectives would be in conflict with each other, which would hurt the performance of the entire chain.  Contract Characteristics Contract Description Characteristics Type Wholesale Supplier Risk of demand Price (upstream firm) uncertainty is borne Contract offers a fixed by retailer. wholesale price Simplest contract w to retailer type; lowest (downstream administration cost. firm) Wholesale Price Contract p (Selling Price) = 100 c (Manufac. Cost) = 20 s (Salvage Value) = 0 μ (Mean Demand = 100 σ (Std. dev.) = 30 w (Wholesale Price)= 20, 30……,90 Calculate Q, Pm, Pr, Psc Wholesale Price Contract: W CSL Q Pm Pr PSC M SC Share Effi. 20 30 40 50 60 70 80 90 Wholesale Price Contract: W CSL Q Pm Pr PSC M SC Share Effi. 20 30 40 50 60 70 80 0.2 75 4500 1140 5640 0.80 0.79 90 Wholesale Price Contract: W CSL Q Pm Pr PSC M SC Share Effi. 20 0.8 125 0 7165 7165 0 1 30 0.7 116 1160 5949 7109 0.16 0.99 40 0.6 108 2160 4825 6985 0.31 0.98 50 0.5 100 3000 3803 6803 0.44 0.95 60 0.4 92 3680 2865 6545 0.56 0.91 70 0.3 84 4200 1976 6176 0.68 0.86 80 0.2 75 4500 1140 5640 0.80 0.79 90 0.1 62 4340 433 4773 0.91 0.67  Impact of Wholesale Price: Supply chain Profit 8000 7165 7109 6985 7000 6803 6545 6176 7165 6000 5949 5640 5000 4825 4773 4200 4500 Retailer Profit Profit 4000 3803 3680 4340 3000 3000 2865 2160 1976 2000 1160 1140 1000 Manufacturer Profit 433 0 0 20 30 40 50 60 70 80 90 Manufacturer Profit Retailer Profit Supply Chain Profit Wholesale Price Contract Description Characteristics Type Buyback Supplier sells Risk of demand Contract each unit to the uncertainty is shared. retailer at a fixed Used in book publishing wholesale price w. and apparel retailing Retailer returns industries. It is not unsold units to the necessary that unsold supplier and units be returned to receive a buyback supplier. Retailer may price ‘b’ for each salvage them and share unsold unit. the cost with the supplier.  Buyback Contract  This contract is popular with a product with limited shelf life.  Computer hardware  Pharmaceuticals & Software  Newspapers &  Magazines Books Buyback Contract: p (Selling Price) = 100 w (Wholesale Price)= 80 c (Manufac. Cost) = 20 (Salvage Value) = 0 μ (Mean Demand = 100 σ (Std. dev.) = 30 b (buyback value) = 20 Calculate Q, Pm, Pr, Psc Buyback Contract: b CSL Q Pm Pr PSC M SC Share Effi. 0 10 20 0.25 80 4706 1224 5930 0.79 0.83 30 40 50 60 70 79 Buyback Contract: b CSL Q Pm Pr PSC M SC Share Effi. 0 0.2 75 4500 1140 5640 0.80 0.79 10 0.222 77 4582 1198 5780 0.79 0.81 20 0.25 80 4706 1224 5930 0.79 0.83 30 0.286 83 4821 1289 6110 0.79 0.85 40 0.333 87 4960 1350 6310 0.79 0.88 50 0.4 92 5110 1430 6540 0.78 0.91 60 0.5 100 5280 1520 6800 0.78 0.95 70 0.667 113 5408 1672 7080 0.76 0.99 79 0.952 150 5003 1937 6940 0.72 0.97  8000 Supply chain Profit 7000 6000 5000 4000 Manufacturer Profit Profit 3000 Retailer Profit 2000 1000 0 -1 9 19 29 39 49 59 69 79 Buyback Price  Impact of “w” and “b” on supply chain performance for decentralized supply chain under buyback contract w b q πm πr πsc M.S. SC Eff. 80 0 75 4500 1140 5640 0.80 0.79 80 30 83 4820 1288 6108 0.79 0.85 0 83 0.85  Impact of “w” and “b” on supply chain performance for decentralized supply chain under buyback contract w b q πm πr πsc M.S. SC Eff. 80 0 75 4500 1140 5640 0.80 0.79 80 30 83 4820 1288 6108 0.79 0.85 71.4 0 83 4266 1842 6108 0.70 0.85 Impact of “w” & “b” on supply chain performance for perfectly coordinated decentralized supply chain p w b q πm πr πsc M.S. SC Eff. 100 30 100 40 100 50 100 60 100 70 100 80 100 90  Impact of “b” on supply chain performance for decentralized supply chain p w b q πm πr πsc M.S. SC Eff. 100 30 12.5 125 896 6269 7165 0.13 1.00 100 40 25 125 1791 5374 7165 0.25 1.00 100 50 37.5 125 2687 4478 7165 0.38 1.00 100 60 50 125 3583 3583 7165 0.50 1.00 100 70 62.5 125 4478 2687 7165 0.63 1.00 100 80 75 125 5374 1791 7165 0.75 1.00 100 90 87.5 125 6274 896 7165 0.88 1.00  Manufacturer versus retailer profit under different demand scenario W = 80; b = 75, Q = 125 Actual Demand Sales Returned Quantity πm πr πsc M.S. 40 70 100 130 160  Manufacturer versus retailer profit under different demand scenario W = 80; b = 75, Q = 125 Actual Demand Sales Returned Quantity πm πr πsc M.S. 40 40 85 1125 375 1500 0.75 70 70 55 3375 1125 4500 0.75 100 100 25 5625 1875 7500 0.75 130 125 0 7500 2500 10000 0.75 160 125 0 7500 2500 10000 0.75  Markdown Money Used by department store chains to share their risk of unsold inventory with their clothing suppliers. When the chain marks down a product below list price, it charges a fraction of the markdown amount called “chargeback” to the supplier. In may 2005, several clothing makers sued departmental store chains, including Sake Fifth Avenue and Dillard’s, for withholding payment & deducting markdown money without authorization and proper recordkeeping. Revenue Sharing Contract This contract is more prevalent in service industries, such as entertainment, telecom, surgery apparatus in medical clinic and ecommerce. Contract Description Characteristics Type Revenue Supplier sells each unit Risk of Sharing to the retailer at a fixed demand Contract wholesale price w. uncertainty is Retailer gives a fixed shared. fraction (1-f )of the sales revenue to the supplier. Revenue Sharing Contract  Many firms have enjoyed remarkable success using revenue-sharing contracts to improve supply chain performance.  The video rental industry and its pioneering deal with movie studios is one such example.  A year after starting its revenue sharing program, industry leader Blockbuster increased its market share by about 5%. Revenue Sharing Contract  Bharti came up with two outsourcing programs, one with their key telecom network equipment vendors, Ericsson, Nokia, and Siemens and the other with their main IT vendor, IBM.  Earlier, Apple used to split app revenue 30-70 with developers, now they changed it to 15-85 split. Get Paid for Your Videos:  Phoenix Marketcity Mumbai Under the revenue sharing model, the mall asked for a percentage of retailer’s gross sales generated over and above minimum guarantee; in return, the retailer did not have to pay large fixed rents. The contract was intended to incentivize retailers to occupy and promote the new mall location. Under revenue sharing deal, the mall collected no income from rents in the first ten months after its launch. Rather than spurring growth, the contract nearly led to business failure.  Revenue Sharing Contract: The music CD manufacturer can decide to reduce the wholesale price to Rs. 30 and ask for a 40% share in revenue from retailer. Therefore for every CD sold in the market, the retailer would get a share of Rs. 60 as revenue (60% of the retail price, f = 0.6). Cost of understocking = p×f-w Cost of overstocking = w-s = w (as, s = 0) Critical Ratio (CSL) = (Cu/Cu+Co)  Cost of understocking = (f×p-w) = 0.6×100- 30 = 30; Cost of overstocking = 30 Critical Ratio (CSL) = (Cu/Cu+Co) = (30/30+30) = 0.5; Corresponding Z = 0, Lz = 0.399; Q = (100 + 0×30) = 100 Expected Stockout = Lz × σ = 0.399×30 = 11.97 Expected Sales = Mean Demand - Expected Stockout = 100- 11.97 = 88.03 Expected excess inventory = Order – Expected Sales = 100-88.03 = 11.97  Expected retailer profit = (Expected Sales× Price ×f) – (Order × Wholesale Price) = (88.03 ×100 ×0.6) – (100 ×30) = 2282 Expected Manufacturer Profit = Q × (w-c) + (1-f) × p × Expected sales = 100 × (30-20) + 0.4 × 100 × 88.03 = 4521 Supply Chain Profit = (Expected retailer profit + Expected retailer profit) = 2282 + 4521 = 6803 Impact of different revenue sharing contracts on supply chain performance for decentralized supply chain w f Order Manuf. Retailer SC Manuf. SC quantity profit profit profit share efficiency 80 0 75 4500 1140 5640 0.8 0.79 30 0.6 100 4521 2282 6803 0.62 0.95 What should be the “w” for same SC Efficiency in WPC Impact of different revenue sharing contracts on supply chain performance for decentralized supply chain w f Order Manuf. Retailer SC Manuf. SC quantity profit profit profit share efficiency 80 0 75 4500 1140 5640 0.8 0.79 30 0.6 100 4521 2282 6803 0.62 0.95 50 0 100 3000 3803 6803 0.44 0.95 Impact of “f” value on supply chain performance for decentralized supply chain. w f Critical Order Manuf. Retailer SC Manuf. SC ratio profit profit profit share efficiency 30 0.4 30 0.5 30 0.6 0.5 100 4521 2282 6803 0.66 0.95 30 0.7 30 0.8 30 0.9 Impact of “f” value on supply chain performance for decentralized supply chain. w f Critical Order Manuf. Retailer SC Manuf SC ratio profit profit profit share efficiency 30 0.4 0.25 80 5317 612 5929 0.9 0.83 30 0.5 0.4 92 5113 1433 6545 0.78 0.91 30 0.6 0.5 100 4521 2282 6803 0.66 0.95 30 0.7 0.571 105 3766 3188 6954 0.54 0.97 30 0.8 0.625 110 2944 4077 7021 0.42 0.98 30 0.9 0.667 113 2064 5016 7080 0.29 0.99  Impact of "f" on SC Performance Supply chain Profit 8000 6954 7021 7080 7000 6803 6545 5929 6000 5317 5113 5016 5000 Expected Profit 4521 4077 4000 3766 Manufacturer Profit 3188 2944 3000 2282 2064 2000 1433 Retailer Profit 1000612 0 0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8 0.85 0.9 Fraction "f" retained by retailer  How to achieve supply chain coordination in Revenue Sharing contract Impact of “w” and “f” on supply chain performance for decentralized supply chain p w f Q Manuf. Retailer Total Manuf. SC proft profit SC share efficiency 100 125 7165 1 100 125 7165 1 100 125 7165 1 100 125 7165 1 100 125 7165 1 100 125 7165 1 100 125 7165 1 Impact of “w” and “f” on supply chain performance for decentralized supply chain p w f Q Manuf Retailer Total Manuf. SC. proft profit SC share efficiency 100 17.5 125 7165 1 100 15 125 7165 1 100 12.5 125 7165 1 100 10 125 7165 1 100 7.5 125 7165 1 100 5 125 7165 1 100 2.5 125 7165 1 Impact of “w” and “f” on supply chain performance for decentralized supply chain p w f Q Manuf Retailer Total Manuf. SC. proft profit SC share efficiency 100 17.5 0.875 125 896 6269 7165 0.13 1 100 15 0.75 125 1791 5374 7165 0.25 1 100 12.5 0.625 125 2687 4478 7165 0.38 1 100 10 0.5 125 3583 3583 7165 0.50 1 100 7.5 0.375 125 4478 2687 7165 0.63 1 100 5 0.25 125 5374 1791 7165 0.75 1 100 2.5 0.125 125 6269 896 7165 0.88 1 Contract Description Characteristics Type Quantity Supplier sells Retailer is fully Flexibility each unit to the protected from the risk Contract retailer at a fixed of demand uncertainty wholesale price up to a limit. Retailer w. Supplier bears the risk of compensate the demand uncertainty retailer for all its above the limit. losses on unsold inventory up to an upper limit. Contract Description Characteristics Type Sales Supplier sells Retailer bears a higher Rebate each unit to the proportion of the risk of Contract retailer at a fixed demand uncertainty for wholesale price demand below the w. Supplier threshold than for gives a rebate r demand above the to the retailer for threshold. each unit sold Useful when retailer above a can exert effort to threshold t. increase demand. Contract Description Characteristics Type Quantity Supplier offer the Retailer discount retailer a wholesale bears the contract price that is risk of decreasing in the demand number of units uncertainty. ordered by the retailer. Consignment Model Here, manufacturer decides how much quantity to be stocked at retailer and the inventory is in the book of manufacturer. Only when the items are sold, the manufacturer raises invoice on retailer. As a result the entire risk is borne by the manufacturer. This would also result in channel coordination. Consignment Model This is prevalent especially in the case of unbranded products where retailer would not like to take any risk associated with the unknown brands. In case where a music artist has produced his own CD, he might be able to convince a music retailer to keep his music CDs on a consignment basic.  Branded jewellery players offer designs of smaller jewellery suppliers who operate with consignment model. Consignment Model This model is also very common in the garment industry and is usually offered by new manufacturers. Retailer is protected as there is no loss incurred if the actual demand turns out to be lower than estimated. Of course, the retailer has an opportunity cost of space used by manufacturer in the consignment model. Therefore, in practice the retailer would not allow to stock unlimited quantity.  Designing Contracts for Creator Economy Several large platforms attract hundreds of millions of viewers with “goods” (or content, such as music, movies, games, TV shows, blogs, recipes, how-to videos, apps, etc.) that are sourced from thousands of creators and whose consumption is financed by advertising payments.  The Creator Economy  Cases: User-generated content  TikTok, YouTube, Niconico, bilibili, Facebook’s in-stream videos…  Clude Snap Games, Twitch,, Plex, Amazon’s IMDb TV,  Comcast’s Peacock, Pluto TV, Xumo, Hulu, Crackle/Sony, The Roku Channel, and broadcast TV The Creator Economy: Process Flow  Summary Variety of contracts enable risk sharing and with a result increase coordination. Coordination results in the better alignment of interests of the parties. This increase profit for both parties and create win-win situations. Therefore, we could refer such contracts as ideal SC contracts.