Incentive Conflicts in a Supply Chain Prof. Suresh K. Jakhar Consider a case of music retailer who has to book in advance the number of CDs that need to be purchased before the release of the movie. Based on the past experience, the retailer is aware that bulk of the demand takes place during the first two weeks of a movie release, During this period, the retailer will not be able to get replenishment from the manufacturer in case of demand turns out to be more than the estimate. However, at the end of two weeks all the unsold CDs will not have any demand and CDs will have to be sold at throwaway prices. For simplicity we would assume that Retailer destroys all the CDs at the end of the season, It is very easy to incorporate disposal value in the calculations, but just for ease of discussion we make this assumption. For example, the retailer buys CDs at Rs 80 each and sells them at Rs. 100 during the first two weeks. After two weeks the retailer will destroy all the unsold stock. Based on experience, the retailer expects that demand for this kind of CDs has a mean demand of 100 and standard deviation of demand of 30. Compare the expected profit of retailer and manufacturer for below mentioned 2 differgat settings. : 1. There are different owners of manufacturer and retail store (decentralized supply chain) ~ 2. Vertically integrated supply chain (manufacturing and retailing performed by same organization) Newsvendor Model sfep by step approach 1. Calculate the newsvendor critical fractile: (Price-Cost) / (Price- Cost + Cost - Salvage Value) = (p-c) ({p-c] + [c-s]) = Cul (Ca Cs) 2. Find the fractile correspondence Z score (from standard normal distribution table) 3. Find the optimal amount of inventory as @ = Mean Demand + (Z scorex standard deviation of the demand) 4. Find the Expected Lost Sales as: find the standard normal loss function value (Lz) correspondence to z value, Expected Lost Sales = L x standard deviation of the demand 5. Find the Expected Sales: Mean Demand - Expected Lost Sales j 6. Expected Profit: Retailer = (Price x Expected Sales) — (Wholesale price x Q) Manufacturer: Wholesale price x Q Calculate the supply chain efficiency as: Total supply chain profit in decentralized supply chain/ supply chain profit in centralized supply chain PageImpact of wholesale pri performance ‘on supply i Cc wholesale] Critical [Onder | Manuf. | Retailer Total SC Manu SC price [ration | Quantity | profit | profit | profit share Efficiency retailer 20 30 40 30 60 70 80 90 Born Toonj— —- 9 — — a Expects. Phot lee prod for deemnttol zeol Sooo. 4ooe Soon. |} a a a Qowt Joo ° WUrolurls Pier, Re 30 4p 50 bo 1 Buyback Contract: Publishing companies in USA came up with innovative idea of buyback scheme in book industry way back in 1930s. They observed that they can reduce the downside risk for the retailer by offering a buyback scheme. As per buyback contract, all the unsold goods at the end of the season can be sold back to publisher at a pre-announced buyback price (b). Under the buyback contract, relevant profits would get computed as follows: 2\PageExpected retailer profit = (expected sales x retail price) + (expected leftover inventory x buyback price) ~ (order * wholesale price) Expected manufacturer profit = order x (wholesale price ~ cost) ~ (expected leftover inventory x buyback price) Expected supply chain profit = {expected retailer profit} + [expected manufacturer profit] = {(expected sales retail price) + (expected leftover inventory x buyback price) ~ (order * wholesale price)} + [order x (wholesale price ~cost) ~ (expected leftover inventory x buyback price)] = (expected sales price) — (order * cost) Impact of “Ww” and “b” on supply chain performance for decentralized supply chain under buyback contracts Ww b Order | Manuf. [Retailer | Total SC] Manuf. ] SC quantity | Profit | Profit | Profit | Share _| Efficiency 80 0 80 30 7a {0 Tmpact of “6” on supply chain performance for decentralized supply chain . Critical ] Order | Manuf. Retailer [Total SC] Manuf. ] SC ration | quantity | Profit | Profit | Profit | Share | Efficiency retailer 0 10 20 30 0 50 60 70 79 3) Page© 40 20 g6 Yo 5e 6 To 19, Buy book far Cb) ‘Impact of “w” and “b” on supply chain performance for perfectly coordinated decentralized supply chain. P wD Onder [Manuf [Retailer | Total] Manuf. | Efficiency profit | profit [SC | share profit 100 30 100 40 100 50 100 60 100 70 100 80 100 90 [Pagecontracts Manufacturer versus retailer profit under different demand scenario for different buying ‘Actual demand Sales Returned quantity Manufacturer profit Retailer profit Supply chain profit ‘Manufacturer share 40 70 100 130 160 Revenue Sharing Contract: ‘Another popular contract where the manufacturer offers a lower wholesale price but additionally get a fractional share of retail revenue. For every rupee earned by the retailer, fraction “P” is retained by retailer and balance is passed on to manufacturer. This contract more prevalent in service industries, such as entertainment, telecom, and ecommerce. Let us examine this arrangement in the context case of music CD. ‘The music CD manufacturer can decide to reduce the wholesale price to Rs. 30 and ask for a 40% share in revenue from retailer. Therefore for every CD sold in the market, the retailer ‘would get a share of Rs, 60 as revenue (60% of the ret slPae price, f= 0.6).supply chain Impact of different revenue sharing contracts on supply chain performance for decentralized w [fF _| Order Manuf. | Retailer [SC profit[ Manuf. | SC efficiency quantity | profit profit share wo fo [7 4500 1140 3640 «(08 0.79 30 [06 [100 4521 2282 6803—*| 0.62 0.95 30 [0 | 100 3000 3803 ewos—«*[ 0.44 095 Impact of “f* value on supply chain performance for decentralized supply chain. w T Critical | Order [Manuf ) Retailer [SC | Manuf. [SC ratio profit | profit | profit | share | efficiency 30 |o4 [02s | 80 s3i7 [era «(5929 [09 [0.83 30 «(OS «oa 3113 1433—~| 6545—«[ 0.78 | 0.91 30~«foe «0S yoo [4521 [2282 [e803 [0.66 | 0.95 30.07 [0571 [10s 3766 [3188 [6954 [054 [097 30 fos 002s |il0 (2944 4077 [7021 [042 [098 30 [os [ower [11s [206r [S016 | 7080 [029 [0.99 Sap~— = — 9» Text — — — — —— Goon + — — —— — — — Soap-— — —— — — Gl Page Fraction featur byImpact of “w” and “f” on supply chain performance for decentralized supply chain : f Order | Manuf. | Retailer | Total] Manuf. [SC prot | profit [SC | share | efficiency 100 17.5 0875 | 125 [896 [6269 «| 7165—«f 0.13 | Se ee ee ae Ss Yoo [125 [0.625 [12s [2087 |aa7e [716s [038 [1 Oe ie ieee lel WO [75 [oa7s |izs |4ae jae? |7ies [0.63 [1 1005 025 [tas |s37aji7or—«| 7s ~—«(0.75 (| T0025 [oi2s jas |o2e9 fave [716s [088 1 Popes GO wi and $” on expected prog fe L_y 4} _4}_+—+-—+— © 0875 0.15 0625 05 0315 025 0.125 Range Revue Shoxing Contant 7|PageEquivalence of Revenue Sharing and Buyback Contracts: For.every buyback contract one can design unique revenue sharing contract which would have exactly same outcome in terms of ordering quantity and expected manufacturer and retailer profit. Critical fractile for buyback contract = (p — ws) / (p - b) Critical fractile for revenue sharing = (fp - w:) / fp ; where wyand weare wholesale price in buyback and revenue sharing contract respectively. Range of equivalent revenue sharing (RS) and buyback contracts. Buyback contract parameters RS contract parameters Manufacturer W b Wr share 30 40 50 60 70 80. 90 Impact of equivalent buyback and RS on timing of cash flow of manufacturing and retailer Buyback contract RS contract with with w=80, b=75._| w=5, £0.25 ‘Actual [Sales] Unsold | Manuf. Retailer [NCF [NCF |NCF | NCF demand quantity | profit | profit | for for for for at the Manuf. | Manuf. | Manuf. | Manuf. end of before | After | before | After the the the the: the season launch | launch | launch | launch 40 70 100 130 160 Bl Page NCF = Net Cash Flow