Supply Chain Contracts That Prevent Information Leakage

Abstract

This paper determines categories of contracts that facilitate vertical information sharing in a supply chain while precluding horizontal information leakage among competing newsvendors. We consider a supply chain in which retailers replenish inventory from a common supplier to satisfy uncertain demand and are engaged in newsvendor competition. Each retailer has imperfect demand information. Yet one of the retailers (the incumbent) has a more accurate demand forecast than the other (the entrant). Information leakage among such competing retailers precludes vertical information sharing and is often the reason for many retailers to abandon collaborative forecast-sharing initiatives, leading to suboptimized supply chains. We show that whether a contract can prevent information leakage depends on how the inventory risk (i.e., cost of supply–demand mismatch) is allocated among the supplier and retailers in conjunction with the allocation of profits. We categorize contracts according to how they allocate inventory risk among firms when compared with a wholesale‐price contract. This comparison yields four mutually exclusive and collectively exhaustive categories of contracts. A downside-protection contract is one that effectively reduces retailers’ cost of excess inventory by shifting some of their overage cost to the supplier. Examples of such contracts include buy-back and revenue-sharing contracts. An upside-protection contract is one that effectively increases retailers’ cost of inventory shortage by shifting some of the supplier’s underage cost to retailers. Examples of such contracts include penalty and rebate contracts. A two-sided protection contract combines the properties of the previous two categories. A no-protection contract is one that fails to shift firms’ cost of inventory shortage or excess from one to the other. Examples of such contracts include wholesale-price and two-part tariff contracts. We show that no-protection contracts, which are extensively used in practice, cannot prevent information leakage, whereas others may do so. We also show that preventing information leakage could be costly for the supply chain (i.e., low channel efficiency). We conclude by illustrating how our unified framework to study a variety of contracts can enable a firm to determine the best-performing contract (among many) that precludes information leakage while almost coordinating the channel. For example, we show why buy‐back contracts perform significantly better than revenue‐sharing or rebate contracts. This paper was accepted by Serguei Netessine, operations management.