Introduction
Supply chains organizations are dependent on various factors and aspects and the forms that they take determines the results for the involved parties. With that, there are various supply contract types that can be applied for their management with varying relationships. In that view, this analysis seeks to analyze the case of the Winter Gear as a producer that has a supply chain relation with Pete’s as the supplier in consideration of the different types of contracts that could be applied for maximization of the profits.
Analysis
Company background
Winter Gear manufactures high-end skiing and snowboarding equipment with its customer base consisting primarily of the die-hard extreme sports enthusiasts. Its supply chain relationship is marked by a situation where no modifications or further orders can be made once one order is placed. Further, the month of March was marked by snowboards that were not sold hence being salvaged. Thus, the product involved is a seasonal one as considered in Newsvendor model. Also, it was estimated that the loss of Winter Gear's goodwill was $250 per unit, and that of Pete's was $200 per unit.
Current situation
In the current situation, the supply chain relationship with Pete is not coordinated considering that the relationship is new and marked by communication problems. With that, there is need to improve on the situation as a means of enhancing the chains profitability. To achieve that, there is need to identify whether the first best order involving a revenue sharing is profit maximizing or not.
Analysis
First best order
In calculation, the first best order quantity for the Winter Gear case is 3851 units, with a maximum expected profit of $4,891,811. A supply chain is coordinated when the maximum forecasted profit, which is the total of expected profits that are obtained by the members of the chain, is achieved while the decision sets leading to that maximum expected income comprise first best possible solution. However, the actions are considered not to be always in best interest of all members of the supply chain as their primary concern is optimizing own profits, with the self-serving approach often resulting in poor performance.
In that respect, the sharing of income strategy providing that first best order is a valuable strategy within an industry in which costs of administration and where effort or retail does not impact much on demand. If there is the availability of systems for tracking rental or sales, revenue verifying by suppliers would not be difficult. To achieve this best order, Winter Gear and Pete would have to be dependent on the other regarding information and resources and that dependency is noted to have been rising in the recent times owing to the outsourcing, rapid innovations as well as globalization. That rise in dependency results in risks to some extent in addition to uncertainty that comes with the benefits.
In a collaborative working environment, it would require joint planning, joint development of product development as well as mutual exchange of information in addition to integrated information systems across the several levels on that network, the long term cooperation as well as the fair benefits and risks sharing. The collaborative chain would thus mean that the two more independent firms’ needs to work jointly in planning to execute the chain operations for greater success compared to when they act in isolation. It is asserted that the continuous coordination and cooperation among the partners is imperative regarding risk avoidance, management, mitigation and avoidance in a manner that the value as well as benefits created get maximized and fairly shared. However, coordination would have been a strategic measure in response to challenges arising from dependencies in the supply chain partners (Xu and Beamon 2006).
Thus, the coordination of the supply chain between the two could have been defined as identification of interdependent chain operations between themselves while devising mechanisms for managing those interdependencies. In that respect, only a measure of the extent of the implementation involved in such aggregated and coordinated mechanism that could help in improvement of the supply chain performance in best interests of the participating members (Arshinder 2008).
The cooperation among the independent but the two related firms would have to be in sharing of resources as well as capabilities for meeting their customers’ extraordinary needs. A particular degree involving the relationship among the chain members is thus a means of sharing rewards and risks that lead to better business performance than could be achieved individually by the firms in the reward risk as well as reward sharing. The coordination may have been achieved if the two chain members; Winter Gear and Pete jointly seek to minimize operating costs as well as share benefits after the joint planning of the scheduling and production policies. They would have to perform different functions and activities such as logistics, ordering, inventory management, forecasting and the product design that is involved in the management of the goods, information as well as money flow. However, although the two have been separately performing the activities in an independent manner, they may benefit from coordination of various activities.
However, the coordination could have faced challenges as Winter Gear and Pete’s individual interest and local opportunistic as well as perspectives behavior could result in mismatch between the demand and supply. With that, the traditional measure of performance that is based on individual performance may become irrelevant to maximization of the supply chain’s profit as coordination. Similarly, traditional policies, mainly the rules as well as the procedures of Winter Gear and Pete may not suit the new conditions involved in the organizational relationship. Such may result from an over dependence on technology as a means of implementing IT. Also, the misalignment could be associated with difficulties involved the dynamic interchange of products and the two partners in the changing environment. Thus, each organization would want to get best suppliers not considering their global location, which brings several risks as well as uncertainties in the management of the chains.
Further a coordinated chain management would have multiple benefits including the elimination of the excess inventory, lead times reduction, increased sales as well as improvement in customer service in addition to efficient development of products, low costs for manufacturing, higher flexibility in coping with the high uncertainty demand, better customer retention as well as revenue enhancement (Arshinder, Kanda and Deshmukh, 2008).
Under the contract of revenue-sharing, the retailer, in this case, the Pete is thus required to pay a wholesaler; Winter Gear, a supplier price for every unit purchased, as well as the revenue percentage generated by the retailer. Also, the revenue is determined by the price and quantity purchased by Pete. However, demand may be stochastic or deterministic, and the revenue is either from outright sales or rentals. The model thus involves the supplier in this case the Winter Gear making their sales to the classical newsvendor with a fixed price or the one who sets his price. In that respect, the Pete would have to choose optimal quantity or price, and the profit from the supply chain would arbitrarily be allocated.
It could also allow the single retailer and a supplier to coordinate effectively their chain, which means the retailer could choose optimal actions in respect to price and quantity to maximize the profit. Thus, Winter Gear the supplier would have to sell at a wholesale price, which is below the production cost, royalties, handling and transportation, but sharing revenue from Pete the retailer would more than offset the loss from sales. This would remain true whether the demand is deterministic or stochastic and whether the product was sold or rented.
However, several limitations are identifiable in the approach involving sharing of the revenue. That explain why the method is not common across industries. Particularly, it characterizes a case in which sharing of revenue provides very little significance compared to contracts of wholesale price which are administratively cheaper. Additionally, sharing of revenue does not harmonize the supply chain to the demand, which depends on retail efforts that are costly.
Also, as opposed to a contract of the wholesale price, the supplier has to be in a position to verify the revenues of the retailers, which is cost incurring hence reducing the profit of the supplier. Second, sharing of revenue does not harmonize the chain of supply when the market is supplied by some competitors and the individual retailer’s revenue depends on competitor’s action.
Finally, sharing of revenue does not harmonize the chain of supply when the effort of the retailer influences demand and that effort, such as service quality, store presentation, and advertising cannot be contracted. Thus, when there is sufficient influence on the demand for effort of the retailer, the contract of revenue sharing should be avoided. However only, quantity discount can allow harmonizing of a chain of supply with a demand that is effort dependent and rents to be allocated without the use of fees that are fixed. In contracts of quantity discount, the cost to the retailer is determined on purchased volume, with decreasing prices in the increase of purchased units.
Given the first best order not being profit-maximizing through revenue sharing approach, a second option involving the wholesale price contract is analyzed as follows.
Wholesale contract price
In view that the wholesale price contract is commonly applied, Pete’s & Winter Gear considered it as a means of coordinating the supply chain and achieving first best profit. Building a data table and the corresponding graph showing the effect of the W on the Pete's Profit, Winters profit as well as the total Supply Chain’s Profit while considering the range of the W to be from 500 to 3000 rements of 250, the following graph summarizes the trend in the profits involved.
Using the graph, the wholesale price maximizing the total supply chain profit is identified as $500. On the other hand, the wholesale price maximizing Winter Gear's profit is $2250. With that, it can be said that Winter Gear will charge the wholesale price, hence maximizing own profit.
The exact wholesale price maximizing the Winter Gear's profit is $2,263.44. The price is the equilibrium price solution contract. Further, the equilibrium sum profit for the supply chain under the wholesale price contract is $3,354,657. In that respect, the difference between first best supply chain profit and the equilibrium supply chain profit in the wholesale price contract is $1,537,154 as shown in the following table.
With the above results, it can be summarized that the wholesale price contract will not coordinate the supply chain.
The wholesale contracts could have been of interest to the firm since it is straightforward and easy to implement. Thus, the Winter Gear could have preferred it better than the other contracts that involve risk sharing such as the revenue-sharing arrangements that achieves the first best as it easily coordinates the decision of the retailer in a newsvendor setting. The wholesale contract could have also been attractive to Winter Gear and Pete given that the alternative contracts have heavier administrative cost burden.
With the contracts of wholesale price, Pete the buyer is charged a payment; wholesale price for every unit that is purchased. However, the contract involving wholesale price would only coordinate the problems of the newsvendor if only the price of wholesale is equal or smaller than supplier`s cost of production, that is, if only the profit of the suppliers is not positive, which is not valuable for suppliers.
That is shown by the results in the above table, and Winter Gear and the Pete's realize that wholesale price contract does not coordinate the supply chain as both are primarily concerned with the optimization of their profits. That is because they render the total supply chain profit as less than the maximum in a phenomenon called double marginalization. With the double marginalization, the Winter Gear seeks to identify whether there is a way it can avoid the problem and is faced with some options including the buyback summarized as follows.
Buy back contract
For a buy back contract, the supplier, in this case, the Winter Gear would charge Pete; the retailer a wholesale price W per unit, and buy back all the unsold units after the selling season for the prior agreed price per unit. The supplier; Winter Gear would then salvage all units bought back at S per unit, so the net cost to the supplier would be, B-S per unit of leftover inventory. Again, the retailer; Pete's determines the order quantity.
In other words, with the contract involving the buy-back, Pete would buy Q units at a price wb for every unit when a season is beginning and might return the Q units by the end of that season if the price b is greater than wb for every unit. Further, the buy back is normally same to the contracts of revenue-sharing, when there is a fixed retail price. However, both contracts would no longer be equal equivalent with the newsvendor price-setting.
It would also offer a mechanism that coordinates distribution supply chain involving Winter Gear as the only supplier and, at least, one retailer, in this case, Pete. The contract is in a manner that Winter Gear charges Pete a low wholesale price for every unit whereas Pete transfers some of their income revenues to that Winter. Consequently, Pete orders the optimal supply quantity from Winter, meaning, the distribution supply chain is well coordinated. The contracts work well within a system having a single season of selling, such as the one identified in the case of the Winter Gear’s products.
Implementation and feasibility
For implementation of the buyback, there would need to be an upstream company and the downstream firm which in this case are Winter Gear and the Pete respectively. That means that the Winter Gear is the supplier while the Pete firm is the retailer. When the Winter Gear produces the products and offers to sell them through Pete, the retailer, the retailer would have to sell the product for a fixed price P. Then Winter Gear would offer a contract for buying back with w wholesale price and b as buyback price. With the assumption that b and w are constant, Pete would then have to decide to agree or not to the contract term. Considering that Pete agrees to the contract, they would have to make a decision whether they should invest their effort in acquiring relevant information. With that, it would be considered that it would cost them some amount for retrieval of the information and zero if they do not seek that information. In a case where Pete would reject the contract, the relationship would be over; hence, the profits for the supplier and the retailer would be 0. On the other hand, in case Pete, as the retailer invests to acquire that information, they would obtain it meaning they either receive good news or bad news. Based on that information, they would then decide on the quantity they should order for maximization of their expected profit. However, if the uncertainty gets realized, Pete would return those goods remaining in the inventory to Winter Gear as the supplier at the prescribed price b.
Also, when the supplier; Winter Gear is the key principal, they can take two approaches to implementing that first best order for the system. They can use the Inventory System that is Vendor Managed (VMI), which allows them to make the quantity decision as that contract of buying back allows Pete the retailer to make the decision on quantity. However, Pete would have to make decision that depends on the information on demand only. On the other hand, in a case where information on demand is common knowledge the VMI system as well as the buying back contract would implement first-best as they would be equal for that supplier. Further, when Pete as the supplier has demand accurate information, the VMI system would obtain that first best by their information such that the VMI system becomes superior to the buying back contract. In practice, VMI system would be prevalent even in cases when the retailer would have easier access to information that is more accurate. Thus, given that it is expensive for Pete to consider investing in information acquiring, there would be need for considering not just the information acquiring cost, but also the due rent for information to the asymmetric information.
Conclusion
In summary, the contrast among the popular approaches including the revenue sharing contract and the wholesale price contract that Winter Gear and Pete applied as well as considering the buyback approach, it leaves the buy back as the feasible contract that the business should apply. That is given its cheap administration as well as considering that it addresses the double marginalization problem, hence maximizing the entire supply chain’s benefits.
References
Arshinder K., Kanda A. and Deshmukh, S. (2008). Supply chain coordination: Perspectives, Empirical Studies, and Research Directions. International Journal of Production Economics 115(2):316–335.
Xu, L. and Beamon, B. (2006). Supply Chain Coordination and Cooperation Mechanisms: An Attribute-Based Approach. The Journal of Supply Chain Management, 42(1): 4 -12.
