A coordination mechanism for a supply chain with demand information updating

We consider the coordination of a supply chain with a long leadtime and demand information updating. In such a supply chain the initial production or key material procurement decision has to be made when there is limited information about the market demand. When it is the time for the final production and/or shipment decision, more accurate demand information is available, which allows the modification of the initial decision so that some costs can be saved. We consider a two-stage supply chain in which the manufacturer decides the initial production quantity in the first stage, and the retailer specifies her order quantity in the second stage after the demand forecast is improved. In this setting, the conventional return mechanism needs to be modified to coordinate the supply chain. We propose a risk sharing contract that requests the retailer to partially compensate for the manufacturer's loss that is attributable to the overproduction in the first stage, and the manufacturer to provide a partial credit for the retailer's loss that results from overstocking in the second stage. Such a contract not only extracts the maximal supply-chain profit, but can also improve the profit of each supply-chain member by tuning the contract parameters. (c) 2006 Elsevier B.V. All rights reserved.