Coordination of a two-level supply chain with contracts

We consider the coordination of planning decisions of a single product in a supply chain composed of one supplier and one retailer, by using contracts. We assume that the retailer has the market power: he can impose his optimal replenishment plan to the supplier. Our aim is to minimize the supplier’s cost without increasing the retailer’s cost. To this end, the supplier (or a trusted third party) proposes to the retailer a contract, which is made of a replenishment plan and a side payment. This side payment compensates the increase of cost of the retailer due to the fact that the proposed replenishment plan may have a cost larger than the retailer’s optimal replenishment plan. We evaluate how much the supplier can gain by using contracts under several scenarios which depend on the side payment coverage. From a theoretical point of view, in all the scenarios, contracts may decrease the cost of the supplier by an arbitrarily large factor. We perfom experiments which measures the gain that can be obtained in practice on various instances types. If side payments are allowed, experiments show that the use of contracts decreases significantly the cost of the supplier, and that side payments on the holding costs are sufficient. We show that if there is no side payment, or if there is no constraint on the side payment, then the problem can be solved in polynomial time. On the contrary, if the side payment is limited to the holding costs of the retailer, then the problem is NP-hard. We extend this study to the case where the information is asymmetric (the supplier—or the trusted third entity—does not know all the costs of the retailer): in this case, the situation is modelled by a screening game.