Analysis of a flexible commitment contract with two-way penalties

Abstract

In this paper, we develop a flexible commitment (FC) contract model - a hybrid contract between quantity flexibility contract and commitment contract with penalties applied to a supplier and a retailer in the supply chain. In the proposed contract, three types of penalty, namely, under purchase, over purchase and under supply penalties are applied to either the supplier or the retailer. For the proposed contract, we firstly determine the profit functions of the supplier and the retailer, and then analyse the optimal reserved supply quantity of the supplier at a given commitment level of the retailer, as well as the optimal commitment quantity of the retailer given information about the reserved supply quantity being known. Guidelines for the supplier to decide on reserved supply quantity and the retailer to decide on commitment quantity are then examined through scenario analysis. Supply chain coordination and contract efficiency are also examined through numerical analysis.