A contract for coordinating capacity decisions in a business-to-business (B2B) supply chain

Abstract We address the problem of coordinating the capacity decisions of two autonomous manufacturers engaged in a buyer-supplier relationship. We propose and analyze a supply contract designed to coordinate the companie's single period capacities so that both parties end up better off than they would by trading solely through the market. The setting is frequently found in supply chains, as the contract does not forbid the parties to also trade in the market. Under the proposed contract, each party decides on his own medium term capacity when demands are still only probabilistically known. When the demand is realized, the supplier must sell to the buyer at a discount contract price up to a contract reservation quantity, and the buyer will pay a contract penalty for each unit he reserved but did not order. The supplier can sell any leftover capacity on the market and if the buyer needs more than the reserved quantity, he must purchase from the supplier at market price or from the market if the supplier's capacity does not suffice. The main achievements gained through this research are (i) conditions for the companie's capacity decisions to obtain coordination under the contract, (ii) conditions for the contract to coordinate the parties' decisions and leave both better off, (iii) characterization of contract instances in which the profit can be arbitrarily distributed between the parties, and (iv) identification of two distinct kinds of gain produced by the contract. Finally, we illustrate the main properties of the contract with numerical examples.