Fast-ship commitment contracts in retail supply chains

Abstract

This article analyzes three types of supply contracts between a supplier and a retailer when both agree as follows—if a customer experiences a stockout, then the purchased item can be shipped to the customer on an expedited basis at no extra cost. This practice is referred to as the fast-ship option in this article. In the first contract (Structure A), the supplier specifies a total supply commitment and allows the retailer to choose its split between the initial order and the amount left to satisfy fast-ship orders. In the other two contracts (Structures B and C), the supplier agrees to fully supply the retailer’s initial order but places a restriction on the quantity available for fast-ship commitment. The difference between the second and third contracts is that in contract Structure B the supplier moves first, whereas in contract Structure C the supplier determines its commitment after observing the retailer’s order. The supplier’s and the retailer’s optimal decisions and preferences are characterized. The question of how the supplier and the retailer may resolve their conflict regarding the preferred contract type is addressed. [Supplementary materials are available for this article. Go to the publisher’s online edition of IIE Transactions for proofs.]

Keywords:

• Supply contracts
• fast-ship option
• stockouts
• partial backorders
• newsvendor model