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Improving Supply Chain Performance and Managing Risk Under Weather-Related Demand Uncertainty

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  • Frank Youhua Chen

    (Department of System Engineering and Engineering Management, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong)

  • Candace Arai Yano

    (Haas School of Business and Industrial Engineering and Operations Research Department, University of California, Berkeley, Berkeley, California 94720)

Abstract

We consider a manufacturer-retailer supply chain for a seasonal product whose demand is weather sensitive. The retailer orders from the manufacturer (supplier) prior to the selling season and then sells to the market. We examine how a manufacturer can structure a weather-linked rebate to improve his expected profit. The proposed class of rebate contracts offers several advantages over many other contract structures, including no required verification of leftover inventory and/or markdown amounts, and no adverse effect on sales effort by the retailer. We provide a thorough analysis of the manufacturer's and retailer's decisions in this context. We show that the weather-linked rebate can take many different forms, and this flexibility allows the supplier to design contracts that are Pareto improving and/or limit his risk in offering the contract and the retailer's risk in accepting it. For weather rebates with certain characteristics, the manufacturer can fully hedge his risks of offering a weather rebate by paying a risk premium; we show how this can be accomplished. We also show that the basic structural results extend to settings in which the two parties would like to limit their risk.

Suggested Citation

  • Frank Youhua Chen & Candace Arai Yano, 2010. "Improving Supply Chain Performance and Managing Risk Under Weather-Related Demand Uncertainty," Management Science, INFORMS, vol. 56(8), pages 1380-1397, August.
    • Handle: RePEc:inm:ormnsc:v:56:y:2010:i:8:p:1380-1397
    DOI: 10.1287/mnsc.1100.1194
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