Supplier Commitment and Production Decisions Under a Forecast-Commitment Contract

Abstract

Manufacturing firms in capital-intensive industries face inherent demand volatility for their products and the inability to change their capacity quickly. To cope with these challenges, manufacturers often enter into contracts with their customers that offer greater certainty of supply in return for more predictable orders. In this paper, we study a "forecast-commitment" contract in which the customer provides a forecast, the supplier makes a production commitment to the customer based on the forecast, and the customer's minimum order quantity is a function of the forecast and committed quantities. We provide a complete analysis of the supplier's decisions when there is a single customer facing uncertain demand. We first show that the supplier has two dominant commitment strategies: committing to the forecast or committing to the production quantity. We then characterize the jointly optimal commitment and production strategy for the supplier and extend the results to consider a capacity constraint. We show that the proposed contract can moderate the supplier's motivation to underproduce, and due to the structure of the contract and the form of the supplier's optimal strategy, also limits the customer's incentive to overforecast. We also provide results for a capacitated two-customer example, which show that the supplier's choice of production quantity for each customer is not necessarily nondecreasing in the total available capacity.supply contracts, information sharing, capacity allocation, quantity flexibility

Impact of flexible contracts on the performance of both retailer and supplier

“…A number of studies have shown that providing the expedited-delivery option at a premium increases the coordination efficiency of a supply chain and that upward inventory adjustment policies can lead to a reduction of demand variance (Donohue, 2000;Ernst and Cohen, 1992;Moinzadeh and Nahmias, 2000). While Durango-Cohen and Yano (2006) and Hsu and Chen (2011) demonstrate that properly designed contracts can alleviate suppliers' tendency to underproduce and tame retailers from overforecasting, DeYong and Cattani (2012) argue that the joint ability of unlimited expediteddelivery and cancellation increases retailer's expected profits significantly. Our work differentiates itself from the aforementioned papers in that we consider both forms of flexible contracts as well as a limited expedited-delivery option, both of which are more practically realistic assumptions.…”

Coordinating decisions by supply chain partners in a vendor-managed inventory relationship

“…For instance, the vendor may have to reserve a certain amount of its own capacity for the VMI relationship. The vendor's decision on the capacity reservation is important, since it will affect the vendor's cost to make and deliver the products to the retailer and also the level of inventory the vendor wants to keep on the retailer's premise [16]. Another set of mechanisms is operational, i.e., the supply chain participants utilize these mechanisms as relatively short-term levers: the retailer's pricing strategy is one of such operational levers.…”

Supply Chain Commitment Contract Model Based on Uncertainty Theory under Uncertain Market Information

“…On the other hand, the wholesaler will improve its degree of information sharing to exchange. Durango-Cohen and Yano [28] studied a commitment contract between ASIC manufacturers and customers, in which the manufacturer would commit a minimum supply quantity to a customer, when he provided a demand forecast and commit to buy some of them at least. Similar commitment contracts are also described in Tsay [29], Tsay and Lovejoy [30].…”