Contracts between an e-retailer and a third party logistics provider to expand home delivery capacity

One of the fundamental challenges encountered by e-retailers is the incapability of on-time delivering products due to insufficient freight shipping capacity, especially when demand fluctuates. Meanwhile, Incidents like the current global pandemic have further exacerbated such a challenge by causing fluctuations in online demand for products like groceries. To address this, e-retailers can adopt third-party logistics providers (3PLs) as business partners. Specifically, this paper aims to address freight shipping fulfillment policies by considering an e-channel where an e-retailer (e.g., e-grocer) has a limited in-house shipping fleet and can hire additional shipping services from a 3PL to encounter demand volatility. We evaluate and compare two different contracts from the perspective of the e-retailer/3PL and e-channel: (1) a conventional contract in which the e-retailer hires shipping services from a 3PL in advance, but in case of not exercising units of hired service, incurs a penalty, and (2) an option contract in which the e-retailer can reserve/exercise shipping services from 3PL who decides on contract terms. We find that when e-channel demand volatility is high the option contract results in e-channel coordination, and both parties are better off. We further demonstrate that when e-channel demand volatility is low, the option contract is detrimental for the e-retailer and a profitable case for 3PL. Thus, the e-retailer prefers to participate in the conventional contract, as opposed to the priority of 3PL and e-channel.