Buyback contracts to solve upstream opportunism

Abstract

We provide another explanation for the prevalence of buyback provisions in wholesale contracts. As opposed to the existing literature which focuses on demand uncertainty, we show that buyback provisions may help an upstream supplier to alleviate the opportunism problem which arises due to strategic uncertainty. Within two different industry structures, first with a vertically integrated manufacturer and an independent retailer, then with an upstream-only manufacturer and two competing retailers, we show that a buyback contract may yield the industry profit maximizing outcome. Upstream marginal costs and retailer demand elasticity play an important role in determining the success of the buyback clause. A dual-channel supply chain is more effective in achieving coordination via buybacks.