Conditional responsive pricing contracts: Balancing flexibility and stability in supply chains with fluctuating input costs

This paper explores contract design for supply chains in which upstream manufacturers are exposed to raw material price volatility. To balance pricing flexibility and stability, we propose a novel Conditional Responsive Pricing contract. Unlike conventional Weighted Pricing contracts, which set wholesale prices as a linear combination of futures and spot prices constrained to full exposure, our proposed contract introduces two key innovations. First, it allows supply chain partners to either amplify (“over-exposure”) or dampen the responsiveness of wholesale prices to spot price fluctuations. Second, it incorporates a tolerance threshold that determines when price adjustments are triggered, thereby providing selective price stability. We analyze the optimal contract design in a single-manufacturer, single-retailer supply chain. Our analysis reveals that the manufacturer benefits from dampening spot-price fluctuations when employing a medium level of market responsiveness, but becomes worse off as responsiveness increases further. Conversely, strategically amplifying wholesale price responsiveness to spot price volatility can significantly increase the retailer’s profit and overall supply chain efficiency. Regarding the tolerance threshold, we discover a volatility shield effect that demonstrates how threshold-based pricing can strategically balance the opposing profit interests of the manufacturer and retailer. Increasing the threshold benefits the retailer but harms the manufacturer at low responsiveness levels, with the effect reversing when responsiveness is high. Our comparative analysis shows that although the manufacturer’s maximum attainable profit is similar under both contracts, the Conditional Responsive Pricing contract yields higher retailer’s profit and greater overall supply chain efficiency than the Weighted Pricing contract.