Delegation with buy-back contract in a fashion supply chain under demand uncertainty

Abstract

We consider a three-tier supply chain with an original equipment manufacturer (OEM, the fashion brand), a contract manufacturer (CM), and a material supplier. There exist two typical outsource structures: control and delegation, where control refers to that the OEM only outsources products production to the CM, while delegation refers to that the OEM outsources both products production and materials procurement to the CM. Under delegation, buy-back contract is commonly adopted, where the OEM can return the unsold products to the CM at the end of selling season, shifting part of overstock risk to the CM. We find that with wholesale price, control is always more beneficial than delegation to the OEM. However, delegation with buy-back contract might benefit the OEM. We identify a demand enlargement effect, a wholesale complementary effect and a wholesale substitution effect of the buy-back price. We find that these three effects influence the OEM's preference over control and delegation. We further study the impact of demand uncertainty on the OEM's preference. We find that when demand uncertainty is relatively high and buy-back price is moderate, delegation dominates control.