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

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.