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Shared-Savings Contracts for Indirect Materials in Supply Chains: Channel Profits and Environmental Impacts

Author

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  • Charles J. Corbett

    () (The Anderson School at UCLA, 110 Westwood Plaza, Box 951481, Los Angeles, California 90095-1481)

  • Gregory A. DeCroix

    () (The Fuqua School of Business, Duke University, Durham, North Carolina 27708)

Abstract

There are many materials for which the quantity needed by a firm is at best indirectly related to the quantity of final product produced by that firm, such as solvents in manufacturing processes or office supplies. For any such "indirect" materials, an inescapable incentive conflict exists: The buyer wishes to minimize consumption of these indirect materials, while the supplier's profits depend on increasing volume. Both buyer and supplier can exert effort to reduce consumption, hence making the overall supply chain more efficient. However, no supplier will voluntarily participate unless contract terms are fundamentally revised. This can be done through a variety of "shared-savings" contracts, where both parties profit from a consumption reduction. This paper analyzes several such contracts currently in use for chemicals purchasing. We show that such contracts can always increase supply-chain profits but need not lead to reduced consumption. We analyze equilibrium effort levels, consumption, and total profits, and show how these change with the contract parameters. We find that the goals of maximizing joint profits and minimizing consumption are generally not aligned. Also, surprisingly, a decrease in a cost parameter can lead to a decrease in profits; it may be necessary (but is always possible) to renegotiate the shared-savings contract to reap the benefits of a cost decrease.

Suggested Citation

  • Charles J. Corbett & Gregory A. DeCroix, 2001. "Shared-Savings Contracts for Indirect Materials in Supply Chains: Channel Profits and Environmental Impacts," Management Science, INFORMS, vol. 47(7), pages 881-893, July.
  • Handle: RePEc:inm:ormnsc:v:47:y:2001:i:7:p:881-893
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    File URL: http://dx.doi.org/10.1287/mnsc.47.7.881.9802
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    References listed on IDEAS

    as
    1. Sugato Bhattacharyya & Francine Lafontaine, 1995. "Double-Sided Moral Hazard and the Nature of Share Contracts," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 761-781, Winter.
    2. Fleischmann, Moritz & Bloemhof-Ruwaard, Jacqueline M. & Dekker, Rommert & van der Laan, Erwin & van Nunen, Jo A. E. E. & Van Wassenhove, Luk N., 1997. "Quantitative models for reverse logistics: A review," European Journal of Operational Research, Elsevier, vol. 103(1), pages 1-17, November.
    3. Lippman, Steven A. & Mamer, John W. & McCardle, Kevin F., 1987. "Comparative statics in non-cooperative games via transfinitely iterated play," Journal of Economic Theory, Elsevier, vol. 41(2), pages 288-303, April.
    4. GĂ©rard P. Cachon & Paul H. Zipkin, 1999. "Competitive and Cooperative Inventory Policies in a Two-Stage Supply Chain," Management Science, INFORMS, vol. 45(7), pages 936-953, July.
    5. Kim, Son Ku & Wang, Susheng, 1998. "Linear Contracts and the Double Moral-Hazard," Journal of Economic Theory, Elsevier, vol. 82(2), pages 342-378, October.
    6. Robert D. Klassen & Curtis P. McLaughlin, 1996. "The Impact of Environmental Management on Firm Performance," Management Science, INFORMS, vol. 42(8), pages 1199-1214, August.
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