Use of Supply Chain Contract to Motivate Selling Effort

Selling of a product is often delegated by the Original Equipment Manufacturers (OEM) to another firm called sales agent. The OEM needs to devise a mechanism to motivate the agent to exert higher marketing effort in order to boost her sales revenue. She also needs to design a profit allocation scheme, a complex task because of the fact that she has incomplete information about the agent’s marketing cost. In this chapter, two important contract forms are analyzed, compared and the OEM’s strategy are developed. Closed form solutions have been derived for three decision variables: marketing effort, order quantity and retail price for both forms of contracts. The revelation principle has been applied in that derivation which find inefficiency and “distribution distortion” due to information asymmetry. We show that the two contract forms perform differently, and each party’s preference toward a particular contract form is linked with the total reservation profit level and/or the sales agent’s cost type. We find that full trading opportunity, as in the full information case, cannot be achieved by any of the two contracts and the OEM suffers due to information deficiency. The chapter also identifies guidelines for the OEM to exert higher control or be more flexible. Further research avenues are also identified.