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Facilitating Demand Risk-Sharing with the Percent Deviation Contract

In: Supply Chain Coordination under Uncertainty

Author

Listed:
  • Matthew J. Drake

    (Duquesne University)

  • Julie L. Swann

    (Georgia Institute of Technology)

Abstract

Suppliers do not have much incentive to build capacity for supply chains with stochastic demand in which the buyer bears little or no inventory risk. This hinders the supply chain from satisfying the optimal amount of customer demand from a channel perspective. We describe and analyze the percent deviation contract as an innovative mechanism to improve the overall performance of this type of supply chain. This contract induces a dynamic game of perfect information, and we characterize the subgame-perfect Nash Equilibria under various contract scenarios. We establish ways to set the contract parameters to coordinate the supply chain under uncertainty and show that the percent deviation contract is able to achieve channel coordination in some cases where the quantity flexibility contract fails. In order to aid the implementation of the percent deviation contract in practice, we develop ways to set the parameters to satisfy the buyer’s individual-rationality constraint.

Suggested Citation

  • Matthew J. Drake & Julie L. Swann, 2011. "Facilitating Demand Risk-Sharing with the Percent Deviation Contract," International Handbooks on Information Systems, in: Tsan-Ming Choi & T.C. Edwin Cheng (ed.), Supply Chain Coordination under Uncertainty, pages 131-163, Springer.
    • Handle: RePEc:spr:ihichp:978-3-642-19257-9_6
    DOI: 10.1007/978-3-642-19257-9_6
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