Quantity flexible contract under information asymmetry

ABSTRACT

In this paper a quantity flexible contract is designed in a two-echelon supply chain with a single manufacturer and a retailer. Specific type of products are considered for which the customers place orders with the retailer prior to the beginning of the selling season. The exact demand is known to the retailer only at the beginning of the selling period once all the orders have been placed. The demand patterns during the period of the placement of orders from the customers are considered to be the private information of the retailer. Under such an environment of information asymmetry a contract between the manufacturer and the retailer is proposed which enables the retailer to order the exact realized demand from the manufacturer. The underlying adverse selection model is developed and analyzed in a principal-agent framework. The quantity flexible contract derived in this paper enables the retailer to place an order equal to the exact market demand for all types of demand patterns which the retailer may encounter; thus, the manufacturer receives his market share to the fullest extent. Under normal circumstances, the retailer may have to forego sales when situations of unusually high demand pattern arise, resulting in an opportunity cost. However, the quantity flexible contract derived in this paper enables the retailer to satisfy even such high demand. The contract design thus enables a win-win situation for the manufacturer as well as the retailer.

KEYWORDS:

• Supply chain coordination
• quantity flexible contract
• information asymmetry
• adverse selection
• mechanism

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Notes on contributors

Dereje Asfaw

Dereje Asfaw is currently Assistant Professor and Head of Production Engineering Department at Defence University, College of Engineering, Ethiopia. He received his PhD in Industrial and Management Engineering from Indian Institute of Technology Kanpur. His research interests include Supply chain management, Operations management, Production planning and control.

Sri Vanamalla Venkataraman

Sri Vanamalla Venkataraman is currently Associate Professor in the Department of Industrial and Management Engineering, Indian Institute of Technology Kanpur. She received her PhD from Indian Institute of Science, Bangalore. Her research interests are Supply chain contracts, Optimization and Game theory.