The Optimal Contract Complexity for Coordination Mechanisms of Supply Chain

Abstract

This paper considers a supply chain system which consists of a supplier and a retailer. The purpose is to investigate the impact of contract complexity on supply chain coordination under complete information. The supplier drafts contracts, which include wholesale price contracts and simple quantity discount contracts. These contracts are of different complexity. The retailer chooses one of the supplier-designed contracts to optimize its profit. This study shows that a complex contract with an infinite number of price breaks can achieve the coordination of a general supply chain. It can also arbitrarily distribute supply chain profit under mild conditions. Theoretically, this is the optimal contract. However, it is difficult to implement in practice. Complex contracts with limited price breaks can improve the performance of the decentralized supply chain system compared to simple contracts (i.e. wholesale price contracts), but neither can coordinate the general supply chain. In addition, as the complexity of the contract increases, the performance of the decentralized supply chains continues to decline. This means that the increased in contract complexity does not necessarily increase the efficiency of supply chain contracts. Our study suggest that a three-price contract (all-unit quantity discount contract with two price breaks), although theoretically suboptimal, is sufficient for a general supply chain and should be preferred in practice.