Designing structured supply contracts under demand and price uncertainty in an open supply chain

Abstract

This paper develops an integrated model for analyzing and designing structured supply contracts from the perspectives of the buyer, the supplier, and the entire supply chain in an open supply chain. We first present a flexible framework that encapsulates a wide range of contracting types that have been studied previously. We then introduce the concept of relative contract value vis-a-vis a reference alternative, which facilitates addressing explicitly both the demand uncertainty and the price uncertainty within which real supply relationships operate. To guide practitioners in designing optimal supply contracts, we derive closed-form expressions for optimal contract structure, quantity commitment and flexibility, pricing, and sharing policy as well as the conditions to maximize total supply chain profitability associated with a contract. Our research demonstrates that structured contracts consisting of several fixed and/or flexible components are capable of maximizing total supply chain profit and allocating profit between contracting parties arbitrarily.