Impact of flexible contracts on the performance of both retailer and supplier

Abstract

In today’s global environment supply chains should be agile and responsive. Ideally, suppliers would like to know the order quantities with enough lead-time to set up the production process and schedule for delivery. However, retailers cannot predict demand accurately and thus both suppliers and retailers may incur significant losses due to under-stocking and/or over-stocking. To attenuate this effect, one of the viable practices is that suppliers impose minimum Order Quantity Commitments (OQC) for regular orders and penalties for reduced orders, while providing retailers with expedited-delivery options at premium costs if needs arise. In this paper, we introduce a methodology to assist in developing inventory management policies to optimize the expected profit. Our model considers a two-period setting where retailers place orders according to pre-sale forecasts but then have the opportunity to update their orders just prior to the season according to the most recent forecasts and the current inventory level. Utilizing the newsvendor model and dynamic programming methods, we obtain the optimal ordering and replenishing policies that maximize the expected profits of retailers. We then analyze the impacts of these flexible terms on the performance of both the retailer and the supplier.