Synchronizing Global Supply Chains: Advance Purchase Discounts

Abstract

We study the economics of sharing demand information between a dual sourcing firm and its network of retailers. Our analysis demonstrates that employing Advance Purchase Discount (APD) contracts in these supply chains removes significant impediments to information sharing. Essentially, these contracts synchronize the timeline of the dual sourcing firm's decisions with the actions of its network of retailers. This enables accurate, timely, and self-enforcing information sharing, which reduces the demand - supply mismatches, and improves the profitability of each of the agents in the supply chain. We provide prescriptions on the appropriate design of contracts that enable this Pareto-improving information sharing. Next, we extend this analysis to incorporate realistic constraints on the dual sourcing firm's limited knowledge of its retailers' operational costs and information quality. We characterize “certainty-equivalent” values of the unknown retailer parameters, which facilitate analogous prescriptions for the design of APD contracts in these realistic settings. It is interesting that the unobservability of retailer parameters leads to an asymmetric and “degree-of-unobservability dependent” departure from the full-observability design of the APD contract. If the uncertainty in the unobserved parameter is small, then the optimal discount is higher compared to the case of full observability; conversely, when the uncertainty is large, the optimal discount is lower. It is significant that, despite the departure in the design of the APD contract, this analysis reiterates that the benefits of APDs persist even under this practical constraint. Finally, we report on the application of our prescription to a U.S.-based apparel wholesaler. Using data derived from the operations of this firm, we estimate that APD-enabled improved information sharing can increase net profits by about 17%.