Channel Coordination for a Supply Chain with a Risk‐Neutral Manufacturer and a Loss‐Averse Retailer*

Abstract

This article considers a decentralized supply chain in which a single manufacturer is selling a perishable product to a single retailer facing uncertain demand. It differs from traditional supply chain contract models in two ways. First, while traditional supply chain models are based on risk neutrality, this article takes the viewpoint of behavioral principal-agency theory and assumes the manufacturer is risk neutral and the retailer is loss averse. Second, while gain/loss (GL) sharing is common in practice, there is a lack of analysis of GL-sharing contracts in the supply chain contract literature. This article investigates the role of a GL-sharing provision for mitigating the loss-aversion effect, which drives down the retailer order quantity and total supply chain profit. We analyze contracts that include GL-sharing-and-buyback (GLB) credit provisions as well as the special cases of GL contracts and buyback contracts. Our analytical and numerical results lend insight into how a manufacturer can design a contract to improve total supply chain, manufacturer, and retailer performance. In particular, we show that there exists a special class of distribution-free GLB contracts that can coordinate the supply chain and arbitrarily allocate the expected supply chain profit between the manufacturer and retailer; in contrast with other contracts, the parameter values for contracts in this class do not depend on the probability distribution of market demand. This feature is meaningful in practice because (i) the probability distribution of demand faced by a retailer is typically unknown by the manufacturer and (ii) a manufacturer can offer the same contract to multiple noncompeting retailers that differ by demand distribution and still coordinate the supply chains.

Benefit and risk analysis of consignment contracts

“…By Markowitz (1959)'s MV theory, the use of MV objectives helps model and study the risk aversion preferences of supply agents into the contract setting mechanism, Chiu and Choi (2013) present a review of related papers in the literature that focus on MV analytical models. Some other recent research works which include risk analysis/issues in the scope of supply chain coordination include a study of the risk-free perishable item returns policy with a risk neutral retailer in a manufacturer-retailer two-echelon supply chain (Webster and Weng 2000), a study on contracting scheme with risk preferences considerations (Bassok and Nagarajan 2004), a discussion on the channel coordination problem with a risk averse retailer (Gan et al 2005), a quantitative analysis of the role of intermediaries in supply chains to reduce financial risk (Chen and Seshadri 2006), a study on coordinating the supply chain with a risk neutral manufacturer and a loss averse the retailer (Wang and Webster 2007), an MV analysis of quick response policy in fashion supply chains (Choi and Chow 2008), an MV analysis of RFID equipped VMI supply chain (Choi 2011), a mean-variance approach of the multi-period risk minimization inventory models for fashion product purchasing (Choi 2013), and a mean-risk analysis for the wholesale price contract with a supplier-retailer supply chain facing a stochastic price-dependent downward-sloping demand curve (Zhao et al 2014). In this paper, we apply the mean-downside risk approach in examining the risk sharing related issue in the two consignment contracts.…”

Loss Aversion and Residential Property Development Decisions in the People's Republic of China: A Semi-Parametric Estimation

“…Other promising applications include the optimal contract form and compensation schemes for loss-averse chief executive officers (de Meza and Webb 2007, Dittmann et al 2010, and Herweg et al 2010; consumption insensitivity to bad news of future income (Bowman, Minehart, and Rabin 1999); optimal ordering when managers or news vendors are loss averse (Ho et al 2010, Wang and Webster 2007, and Wang 2010; and so on.…”

Behavioral research and empirical modeling of marketing channels: Implications for both fields and a call for future research

“…Reference price dependence has been empirically demonstrated in marketing contexts (e.g., Kalyanaram and Winer 1995) and, together with loss aversion, incorporated in consumer choice models (e.g., Hardie, Johnson, and Fader 1993). However, few game-theoretic models of marketing channels to date incorporate these behavioral regularities (exceptions are Shi andXiao 2008, andWang andWebster 2007), even though they have been shown to affect coordination in marketing channels (Ho and Zhang 2008). For example, the simplest form of nonlinear pricing contracts that achieve coordination in a dyadic channel is a two-part tariff that consists of a lump-sum fixed fee and a marginal wholesale per-unit price (Moorthy 1987).…”