A return-policy contract with a stock-dependent demand and inventory shrinkages

Abstract

We study a decentralized supply chain in which a manufacturer supplies a newsvendor-type item to a retailer in a stock-dependent demand market, considering temporary and permanent inventory shrinkages. The manufacturer offers a cheaper-wholesale-price, buy-all-back contract to operate the chain as a centralized supply chain. The purpose is to coordinate the chain and create a win–win situation by jointly determining the order quantity and negotiating the wholesale price. We consider the retailer's ignorance of inventory errors and unwillingness to share information, and we construct a range for the negotiated wholesale price in which it not only achieves Pareto efficiency but also encourages the retailer's cooperation with the inventory information. We find that the retailer bears more risk for inventory errors even when our contract is in place. We also learn that the impact of the stock-level demand stimulation effect on chain profit outweighs the impact of the inventory errors if the levels of inventory shrinkage are below our obtained upper bounds.