Supply chain contracts for capacity decisions under symmetric and asymmetric information

Abstract

Production capacity decision under random demand is an important factor that significantly effects supply chain profits. It is realized in decentralized supply chains that the suppliers build capacity levels that are less than optimal for the total supply chain, since the supplier incurs all the cost and bears all the risk for the built capacity. To improve the supply chain performance, we analyze supply chain contracts considering capacity decisions in a two-party supply chain composed of a single manufacturer and a single supplier. We analyze and compare four well-known contracts, namely, simple wholesale price only contract, linear contract, cost sharing contract and revenue sharing contract under symmetric and asymmetric information about the supplier’s capacity building cost. The choice of the contract and determining the optimal contract parameters might be difficult for the manufacturer, especially if he has incomplete information about the supplier. In the asymmetric information models, we analyze the screening problem of the manufacturer when designing a menu of contracts without exact knowledge of the supplier’s capacity cost. We determine the optimal menu of contracts designed for both high and low cost suppliers and analyze their results through numerical experiments. Focusing on the capacity decisions under random demand, we aim to answer the three questions: (i) Which contracts coordinate the supply chain; (ii) Which contracts allow for any division of the supply chains profit among the firms; and (iii) Which contracts are worth adopting. We find the optimal contract parameters, determine the respective profits obtained by the supply chain members, and find which contracts would be better to use for the companies depending on the system parameters in different settings by analyzing and comparing the efficiencies of the contracts.