Energy Efficiency Contracting in Supply Chains Under Asymmetric Bargaining Power

Evidence shows that suppliers refrain from investing in energy efficiency (EE) measures because they fear that a buyer with greater bargaining power will use EE-related cost reductions to push prices down---in the purchase bargaining process---and thereby further reduce the supplier's profit margin; this dynamic leads to inefficient levels of investment in EE due to the so-called holdup problem. Suppliers are also discouraged from EE investment by the uncertainty associated with new technologies. These two issues are studied via our model of the bargaining process, in a two-tier supply chain, between a single supplier and buyer; we analyze how the supplier's EE investment is affected by the buyer's relative bargaining power and also by technology uncertainty. We compare various contracting arrangements commonly used in industry to overcome these obstacles, including price commitment by the buyer and shared investment contracts, while characterizing their optimal properties with respect to different criteria---in particular, supply chain profit and the equilibrium level of EE investment. In terms of both criteria, we find that shared investment contracts perform better than price commitment contracts, although the latter increase supplier profit when the buyer's bargaining power is relatively high. We also show that, in a two-player model, technology uncertainty moderates how the bargaining process affects the supplier's investment behavior.