Simpler and better: Supply chain contracting in the presence of contract unobservability and upstream competition

Abstract

A retail platform or intermediary can purchase products from multiple upstream manufacturers through different types of contracts. Traditional studies assume that the contracts and their terms are common knowledge; that is, each party of the supply chain can observe the contracts reached. In practice, however, this is not necessarily the case. Taking the result under contract observability as a benchmark, this paper investigates the contracting of the supply chain comprised of one retail platform and two upstream manufacturers when contracts are unobservable. Two representative contracts are considered: the traditional and succinct wholesale price contract and the nonlinear, more complicated, two-part tariff contract. We apply the framework of perfect Bayesian equilibrium and also use passive beliefs as an equilibrium refinement criterion to analyze the model. Our study shows that the classical result – that the more complicated contract can increase channel profitability – may no longer be valid when contracts are unobservable to competing manufacturers. On the contrary, the manufacturers and the whole supply chain can benefit from adopting wholesale price contracts rather than two-part tariff contracts. To examine the robustness of our findings, we consider a commission fee contract and another classic demand function in an extended analysis, and the results show that the main findings and key insights remain valid. The intuition behind these findings is that the unobservability of contracts affects the opportunistic behavior of competing manufacturers. The practical value of these findings is mainly reflected in the evidence that supply chain members must carefully consider the impact of contract (un)observability when agreeing on contracts.