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Capacity Investments in Supply Chains: Sharing the Gain Rather Than Sharing the Pain

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  • Brian Tomlin

    () (Kenan-Flagler Business School, University of North Carolina at Chapel Hill, Chapel Hill, North Carolina 27599-3490)

Abstract

In this paper, we investigate price-only contracts in supply chain capacity procurement games. For a two-party supply chain, comprising a manufacturer and a supplier that both invest in capacity, we prove the existence of a class of coordinating price-only contracts that arbitrarily allocate the supply chain profit. Moreover, if the supplier's reservation profit is below a certain threshold, the manufacturer's optimal contract is a quantity-premium price-only schedule, that is, the average wholesale price per unit increases in the order size. We prove that the manufacturer prefers simple piecewise-linear quantity-premium contracts to linear contracts and show numerically that such contracts are highly efficient. We extend our results for piecewise-linear price schedules to N-supplier assembly systems. We also enrich the voluntary compliance regime of Cachon and Lariviere (2001). With this enrichment, we prove that share-the-pain contracts, such as firm commitment and options contracts, increase supplier capacity in the full information case, a result that contrasts with that of Cachon and Lariviere. Finally, we investigate when a manufacturer prefers single-breakpoint quantity premiums to firm commitments.

Suggested Citation

  • Brian Tomlin, 2003. "Capacity Investments in Supply Chains: Sharing the Gain Rather Than Sharing the Pain," Manufacturing & Service Operations Management, INFORMS, vol. 5(4), pages 317-333, November.
  • Handle: RePEc:inm:ormsom:v:5:y:2003:i:4:p:317-333
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    File URL: http://dx.doi.org/10.1287/msom.5.4.317.24881
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    References listed on IDEAS

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    1. repec:eee:jomega:v:72:y:2017:i:c:p:71-86 is not listed on IDEAS
    2. Li, Jian & Wang, Shouyang & Cheng, T.C.E., 2010. "Competition and cooperation in a single-retailer two-supplier supply chain with supply disruption," International Journal of Production Economics, Elsevier, vol. 124(1), pages 137-150, March.
    3. Terry A. Taylor & Wenqiang Xiao, 2010. "Does a Manufacturer Benefit from Selling to a Better-Forecasting Retailer?," Management Science, INFORMS, vol. 56(9), pages 1584-1598, September.
    4. Xiang Fang & Kut C. So & Yunzeng Wang, 2008. "Component Procurement Strategies in Decentralized Assemble-to-Order Systems with Time-Dependent Pricing," Management Science, INFORMS, vol. 54(12), pages 1997-2011, December.
    5. Erica L. Plambeck & Terry A. Taylor, 2007. "Implications of Renegotiation for Optimal Contract Flexibility and Investment," Management Science, INFORMS, vol. 53(12), pages 1872-1886, December.
    6. Li, Yongjian & Zhen, Xueping & Qi, Xiangtong & Cai, Gangshu (George), 2016. "Penalty and financial assistance in a supply chain with supply disruption," Omega, Elsevier, vol. 61(C), pages 167-181.
    7. repec:spr:cejnor:v:26:y:2018:i:1:d:10.1007_s10100-017-0474-y is not listed on IDEAS
    8. Wu, Xiaole & Kouvelis, Panos & Matsuo, Hirofumi & Sano, Hiroki, 2014. "Horizontal coordinating contracts in the semiconductor industry," European Journal of Operational Research, Elsevier, vol. 237(3), pages 887-897.
    9. Mathur, Puneet Prakash & Shah, Janat, 2008. "Supply chain contracts with capacity investment decision: Two-way penalties for coordination," International Journal of Production Economics, Elsevier, vol. 114(1), pages 56-70, July.
    10. Li Jiang & Yunzeng Wang, 2010. "Supplier Competition in Decentralized Assembly Systems with Price-Sensitive and Uncertain Demand," Manufacturing & Service Operations Management, INFORMS, vol. 12(1), pages 93-101, January.
    11. Erica L. Plambeck & Terry A. Taylor, 2007. "Implications of Breach Remedy and Renegotiation Design for Innovation and Capacity," Management Science, INFORMS, vol. 53(12), pages 1859-1871, December.
    12. Xiong, Huachun & Chen, Bintong & Xie, Jinxing, 2011. "A composite contract based on buy back and quantity flexibility contracts," European Journal of Operational Research, Elsevier, vol. 210(3), pages 559-567, May.
    13. Berling, Peter & Eng-Larsson, Fredrik, 2017. "Environmental implications of transport contract choice - capacity investment and pricing under volume and capacity contracts," European Journal of Operational Research, Elsevier, vol. 261(1), pages 129-142.
    14. Lu, Lijian & Wu, Yaozhong, 2015. "Preferences for contractual forms in supply chains," European Journal of Operational Research, Elsevier, vol. 241(1), pages 74-84.
    15. repec:spr:annopr:v:257:y:2017:i:1:d:10.1007_s10479-016-2136-1 is not listed on IDEAS
    16. repec:eee:proeco:v:198:y:2018:i:c:p:133-148 is not listed on IDEAS
    17. Sabbaghi, Navid & Sheffi, Yossi & Tsitsiklis, John N., 2014. "Allocational flexibility in constrained supply chains," International Journal of Production Economics, Elsevier, vol. 153(C), pages 86-94.
    18. Claudia Keser & Giuseppe A. Paleologo, 2004. "Experimental Investigation of Supplier-Retailer Contracts: The Wholesale Price Contract," CIRANO Working Papers 2004s-57, CIRANO.
    19. Konur, Dinçer & Toptal, Ayşegül, 2012. "Analysis and applications of replenishment problems under stepwise transportation costs and generalized wholesale prices," International Journal of Production Economics, Elsevier, vol. 140(1), pages 521-529.
    20. Brusset, Xavier, 2009. "Choosing a transport contract over multiple periods," MPRA Paper 18392, University Library of Munich, Germany, revised 09 Jan 2009.
    21. repec:eee:transe:v:106:y:2017:i:c:p:255-275 is not listed on IDEAS
    22. Kyle Hyndman & Santiago Kraiselburd & Noel Watson, 2013. "Aligning Capacity Decisions in Supply Chains When Demand Forecasts Are Private Information: Theory and Experiment," Manufacturing & Service Operations Management, INFORMS, vol. 15(1), pages 102-117, March.
    23. Yang, Jian & Yang, Shitao, 2007. "The use of a premium-payment scheme in a supply chain involving capacity acquisition," European Journal of Operational Research, Elsevier, vol. 181(1), pages 207-223, August.
    24. Zhaoqiong Qin, 2012. "Revenue-sharing in decentralised assembly systems," International Journal of Applied Management Science, Inderscience Enterprises Ltd, vol. 4(1), pages 80-90.

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    Keywords

    Supply Chain; Capacity; Pricing; Coordination;

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