Designing Service Level Contracts for Supply Chain Coordination

Abstract

Supply contracts are used to coordinate the activities of the supply chain partners. In many industries, service level‐based supply contracts are commonly used. Under such a contract, a company agrees to achieve a certain service level and to pay a financial penalty if it misses it. The service level used in our study refers to the fraction of a manufacturer's demand filled by the supplier. We analyze two types of service level‐based supply contracts that are designed by a manufacturer and offered to a supplier. The first type of contract is a flat penalty contract, under which the supplier pays a fixed penalty to the manufacturer in each period in which the contract service level is not achieved. The second type of contract is a unit penalty contract, under which a penalty is due for each unit delivered fewer than specified by the parameters of the contract. We show how the supplier responds to the contracts and how the contract parameters can be chosen, such that the supply chain is coordinated. We also derive structural results about optimal values of the contract parameters, provide numerical results, and connect our service level measures to traditional service level measures. The results of our analyses can be used by decision makers to design optimal service level contracts and to provide them with a solid foundation for contract negotiations.

Service supply chain management: A review of operational models

“…They develop a special class of contracts to coordinate the PSSC system, under which the profits of both parties do not decrease, with at least one being strictly better off (i.e., a Pareto improvement). Sieke et al (2012) propose several service level-based supply contracts to achieve supply chain coordination. They identify the optimal service level contracts and show how the supply chain performance differs.…”

Incentives to improve the service level in a random yield supply chain: The role of bonus contracts

“…First, we only consider the bonus incentives to improve the service level. Other ways, however, can also be explored, such as penalty (Liang and Atkins, 2013;Sieke et al, 2012) and supplier diversification (Hu et al, 2013). It would be interesting to compare the role of these different incentive measures.…”

“…There exists extensive literature on the service-level agreement in a two-echelon inventory system under periodic review (Bollapragada et al, 2004;Katok et al, 2008;Sieke et al, 2012;Liang and Atkins, 2013;Lejeune, 2013). For the single-period problem which is more strongly related to our research, Sethi et al (2007) consider a supply chain wherein the buyer has two procurement opportunities under a service-level constraint and information update.…”

Complexity Dynamic Character Analysis of Retailers Based on the Share of Stochastic Demand and Service

“…The Cournot-Bertrand equilibrium was calculated and the analysis of the equilibrium was also conducted. Sieke et al [6] investigated the service level based supply contracts including flat penalty contract and unit penalty contract in a coordinated supply chain. The optimal values of the contract parameters were decided and service level measures were connected to traditional service level measures.…”