The value of target sales rebate contracts in a supply chain with downstream competition

Abstract

This paper investigates the value of target sales rebate (TSR) contracts from a supply chain perspective. We study a supply chain consisting of a supplier and two downstream retailers. The supplier offers TSR contracts to the heterogeneous retailers that compete with each other. We formulate a stylized model and characterize each player's optimal decisions under different environments (e.g., different market sizes and different degrees of competition intensity). We find that from the viewpoint of a supply chain, TSR contracts are able to encourage retailers to order more from the supplier, therefore generating a higher total profit. In addition, differentiated sales rebates perform better than common rebates, achieving a maximum profit for the supply chain; in equilibrium, any profit allocation is possible between the supplier and either of the two retailers. We extend the model to consider stochastic market demand and find that regular TSR contracts are no longer able to coordinate the supply chain. To improve supply chain performance, a so-called price-dependent TSR contract scheme is developed, under which coordination can be achieved, especially when random demand noise is relatively small compared to the market size. We also discuss demand information asymmetry and find that TSR contracts are able to induce information sharing between the members.