Annals of Operations Research

https://doi.org/10.1007/s10479-021-03969-6

S.I. : DATA-DRIVEN OR IN TRANSPORTATION AND LOGISTICS

Contract strategies in competitive supply chains subject

to inventory inaccuracy

Feng Tao2 · Yanhong Xie2 · Yao‑Yu Wang1   · Fujun Lai3 · Kin Keung Lai4

Accepted: 28 January 2021

© The Author(s), under exclusive licence to Springer Science+Business Media, LLC part of Springer Nature 2021

Abstract
We use a newsvendor model to investigate equilibrium contracting strategies and their
impact on the members in two competing supply chains that are subject to inventory inac-
curacy. The suppliers are Stackelberg leaders and can choose either a wholesale-price con-
tract or consignment contract. As a result, we analyze three cases: the wholesale price con-
tract case, consignment contract case, and hybrid contract case. We first analytically derive
the optimal outcomes of each case and then analyze the equilibrium behaviors of suppliers
and retailers under both symmetric and asymmetric settings. Our results show that the con-
signment contract is no longer the dominant strategy for dominant suppliers when inven-
tory inaccuracy is considered, even though it is considered as the channel-coordinating
contract format in the traditional supply chain. Specifically, in the symmetric case, the
wholesale price contract is the equilibrium contracting strategy when inventory inaccuracy
is below a certain threshold. In the asymmetric case, the hybrid scenario occurs when the
high-cost supplier chooses the wholesale price contract, and the low-cost supplier chooses
the consignment contract when inventory inaccuracy is less than a certain value. Further-
more, our results demonstrate that the threshold point of inventory inaccuracy is interre-
lated with the channel cost-sharing rate and level of chain-to-chain competition between
supply chains.

Keywords  Inventory inaccuracy · Equilibrium contracting · Supply chain management ·

Game theory

* Yao‑Yu Wang
wangyaoyu@suda.edu.cn
1
Research Center for Smarter Supply Chain, Dongwu Business School, Soochow University,
Suzhou, Jiangsu, People’s Republic of China
2
Department of Management Science and Engineering, East China University of Science
and Technology, Shanghai 200237, People’s Republic of China
3
College of Business and Economic Development, University of Southern Mississippi, Hattiesburg,
USA
4
College of Economics, Shenzhen University, Shenzhen, People’s Republic of China

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1 Introduction

In a traditional supply chain, a transaction between an upstream supplier and a downstream

retailer is often conducted under a wholesale price contract, where the retailer purchases
the product at a wholesale price from the supplier and then sells it to end consumers at a
retail price (Lu et al. 2019). As retailers bear all the risk of demand uncertainty under the
wholesale price contract, they tend to order less than they would in the integrated supply
chain case to avoid overstock. As a result, stockout frequently occurs and thus reduces the
profit of the supply chain. For example, the retail stockout rate for fast-moving consumer
products hovers around 8% and stockout costs retailers about 4% of sales, which is trans-
lated into a 4% reduction in earnings per share, not to mention the resultant profit loss for
suppliers (Xu et al. 2016).
To resolve this problem, many supply chain contracts have been proposed and imple-
mented, among which the consignment contract has attracted increasing attention from
both practitioners and academics in recent decades (see, e.g., Adida and Ratisoontorn
2011; Hu et al. 2018; Zhao et al. 2020). Consignment contract refers to a special contract
form in which the supplier retains ownership of the products and receives payment from
the retailer only after a product is sold (Hu et al. 2017; Cao and Fang 2019). It is intuitively
expected that the retailer might benefit from the consignment contract because it can lower
the financial risk associated with carrying inventory by transferring ownership to the sup-
plier. Suppliers may also benefit from the consignment contract because they can obtain
access real-time sales data (e.g., the point-of-sale data) specific to each stock-keeping unit
at each store to improve demand forecasts and replenishment planning (Choi et al. 2019).
Because of these benefits, the consignment contract is now widely used in many industries,
such as the healthcare industry (Adida and Ratisoontorn 2011; Paul et al. 2019) and virtual
product market (Avinadav et  al. 2015; Hu et  al. 2017), in addition to the retail industry
(Lim et al. 2015; Zhao et al. 2020).
However, the majority of studies related to wholesale price contracts and consignment
contracts assume that the inventory is accurate such that a significant and realistic factor
is neglected, that is, inventory inaccuracy, which refers to the discrepancy between the
available stock and inventory records (Tao et  al. 2017, 2019). Typically, inventory inac-
curacy results from inventory shrinkage (e.g., damage/expiration and theft/shoplifting) and
misplacement (e.g., someone placing inventory on the wrong shelf), which is inevitable
in industries (Fan et al. 2015). Generally, from the retailer’s side, only 65% of inventory
records are correct (Tao et al. 2019). Consequently, the available inventory might be less
than the quantity ordered, which further reduces its profitability (Kök and Shang 2014).
Researchers have reported that the profit is reduced by up to 10% because of inventory
inaccuracy (Atali et  al. 2004; Dehoratius and Raman 2008). As a result, under a whole-
sale price contract, because inventory ownership and inventory operation (which includes
ordering, maintenance, marketing, and sales) are retained by the retailer, the retailer takes
the full inventory inaccuracy cost, which might make it reluctant to accept the contract.
However, under a consignment contract, inventory ownership and inventory operation are
separated such that the supplier retains ownership and the retailer is responsible for the
operation. Therefore, the cost that results from inventory inaccuracy is now fully borne by
the supplier, which might reduce its incentive to adopt such a contract.
Additionally, competition is no longer between companies, but rather between supply
chains (Ha and Tong 2008; Shou et al. 2009). Dominant players in one supply chain have
to take their competitors’ contracting strategy into consideration when they choose which

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contract format to offer (Wang et al. 2016). Ultimately, the contract format observed in one
industry might result from chain-to-chain competition (Fang et al. 2016). Inventory inac-
curacy and competition between supply chains are interrelated and affect the decisions and
profits of each member, and in turn affect the performance of the contract formats. This
motivates us to investigate the following research questions:

(1) How do different contracting strategies affect the decisions and profits of suppliers,
retailers, consumers, and the entire supply chain?
(2) Which contract is the best choice for dominant suppliers (or what is the equilibrium
contracting strategy) when the supply chain encounters inventory inaccuracy given two
common types of contract (wholesale price contract and consignment contract)?
(3) How do inventory inaccuracy and level of competition between supply chains affect
the above conclusions?

To answer these questions, we consider two competing supply chains comprising one
dominant supplier and one follower retailer in both instances. Inventory inaccuracy occurs
on the retailer’s side. Market demand is assumed to be uncertain and price sensitive such
that it decreases as the retailer’s price decreases and increases as the competitor’s price
increases. We analytically derive the newsvendor solutions and conduct an intensive
numerical study to investigate the impact of inventory inaccuracy on competing supply
chains’ operational decisions, and importantly, on the contracting strategy used under the
wholesale price contract, consignment contract, and hybrid contract scenarios.
The remainder of this paper is organized as follows: In Sect. 2, we briefly review the
related literature. In Sect.  3, we propose related notation, necessary assumptions, and a
benchmark solution for the centralized supply chain. In Sect.  4, we develop the formu-
lations and analyze the optimal solutions in each scenario under the decentralized sup-
ply chain. In Sect. 5, we present an intensive numerical study and discuss the results. In
Sect. 6, we conclude the paper.

2 Literature review

This paper builds on prior research on contracting strategies (Cachon 2004; Zhang 2010;
Shi and Zhang 2010; Adida and Ratisoontorn 2011) and inventory record inaccuracy
(Camdereli and Swaminathan 2010; Kök and Shang 2014). We discuss these two key
streams separately.
The stream of contracting strategies can be divided into three branches with respect
to competition: vertical competition, horizontal competition, and a combination of ver-
tical and horizontal competition (Adida and Ratisoontorn 2011; Zhang and Chen 2013;
Fang et al. 2016; Chen et al. 2018). Each branch has undergone extensive examination by
researchers, with a resultant large mass of literature on each branch. One well-known paper
by Spengler (1950) indicated the “double marginalization” issue when discussing verti-
cal competition. Subsequently, an increasing number of papers focused on this subtopic,
such as Cachon (2003), Bernstein and Federgruen (2005), and Pan et al. (2010). In these
works, the consignment contract attracted increasing research attention. Wang et al. (2004)
investigated the performance of a supply chain consisting of one supplier and one retailer
under a single product consignment contract with revenue sharing. Considering who was
responsible for inventory, Ru and Wang (2010) categorized the consignment contract into

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two types: vendor-managed inventory and retailer-managed inventory. We use the second
type. In terms of horizontal competition, some works focus on the competition between
two suppliers that provide products to an identical retailer, such as Wang (2006), Cachon
and Kok (2010), Leng and Parlar (2010), and Bian et al. (2020). Others have been inter-
ested in competition between two retailers that order products from an identical supplier,
such as Zhang (2002), Bernstein and Federgruen (2005), Xie et al. (2010), Altug and Ryzin
(2013), and Bian et al. (2014). Finally, chain-to-chain competition is a combination of ver-
tical and horizontal competition (Boyaci and Gallego 2004; Wu et al. 2009; Demirag et al.
2011; Fang et al. 2016).
The other research stream the current paper pertains to is inventory record inaccuracy,
which has proliferated over the last decade (Fleisch and Tellkamp 2005; Thiel et al. 2010;
Kök and Shang 2014; Zhang and Yang 2019; Tao et  al. 2020). Traditionally, inventory
is assumed to be accurate when researchers develop the optimal order quantity. Unfortu-
nately, inventory record inaccuracy is universally recognized in both practice and academia
(Atali et  al. 2004; Dehoratius and Raman 2008). Typically, inventory inaccuracy is clas-
sified into two types: stochastic (Heese 2007) and deterministic (Camdereli and Swami-
nathan 2010). In the stochastic area, Rekik et al. (2008) proposed a newsvendor model to
investigate the impact of stochastic misplaced inventory on ordering decisions. Kök and
Shang (2007) developed the optimal order quantity in a dynamic system, which is subject
to randomly distributed inventory inaccuracy. They did this by proposing a “near optimal
joint inventory inspection approach.” In 2014, the same authors focused on inventory inac-
curacy at different locations by conducting cycle counts to optimize the ordering policy
in a periodic review inventory system. Mersereau (2013) captured stochastic inventory
inaccuracy using a Bayesian inventory record, and subsequently formulated an inventory
replenishment policy and considered it as a Markov decision process. In the deterministic
area, Fan et al. (2015) considered inventory shrinkage and misplaced inventory as the two
main sources of inventory record inaccuracy to analyze the impact of inventory inaccuracy
on the order quantity and supply chain profit. Tao et al. (2019) investigated performance
differences in cases both with and without radio frequency identification in a supply chain
subject to inventory inaccuracy. We consider inventory record inaccuracy as the exogenous
deterministic parameter for the following two reasons: (1) for feasibility, because, as shown
in the main body of the paper, even though inventory inaccuracy is simply determined, the
analysis and proof are sophisticated because the two competing supply chains may both
suffer from inventory inaccuracy; and (2) the conclusions are intriguing and convincing.
Despite its simplicity, we analyze and observe the effect of inventory inaccuracy on the
contracting strategy, in addition to ordering and pricing decisions, which has managerial
implications for competing supply chains.
The literature on inventory management has verified the effect of inventory inaccuracy
on ordering policy (the second literature stream). Additionally, productive research on
competition indicates the importance of inventory management in various types of com-
petition (the first literature stream). Thus, inspired by current research on these two main
streams, we investigate the impact of inventory inaccuracy on the contracting strategy. To
the best of our knowledge, there has been little research on the combination of inventory
inaccuracy and the contracting strategy. Our purpose is to fill this gap by formulating the
newsvendor model and examining the performance of two competitive supply chains that
are subject to inventory inaccuracy under both a wholesale price contract and consignment
contract.
To the best of our knowledge, the work most relevant to this paper is that of Fang et al.
(2016) (hereafter, FWH). These authors examined the impact of competition and the

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channel cost-sharing rate on the contracting strategies of two competing supply chains
under wholesale price contracts, consignment contracts, and hybrid contract scenarios.
Our study bears some resemblance to FWH’s research; however, the most distinguished
difference is that we consider inventory inaccuracy in context to investigate its impact on
contracting policy and operations decisions. Although our objective functions have simi-
larities with the research of FWH (our study contains a parameter to identify inventory
inaccuracy), our analysis is substantially difficult and different from that of FWH. Impor-
tantly and surprisingly, our results are much more attractive than those of FWH. We find
that inventory inaccuracy is a key factor in determining the equilibrium contract format in
two competing supply chains. Conclusions solely built on the channel cost-sharing rate and
horizontal and vertical competition may be only partially evaluated, particularly in sup-
ply chains where inventory inaccuracy is widespread. Specifically, some of FWH’s conclu-
sions are robust and could be easily extended to cover inventory inaccuracy; however, some
are not valid in this paper’s context and need to be extended accordingly. Generally, we
extend FWH’s model and further enrich the authors’ conclusions.

3 Model: preliminary and benchmark solutions

Before presenting the models, we describe the key model’s notation and assumptions, and
then provide basic results for the centralized supply chain as benchmark solutions.

3.1 Model description

We consider two competitive supply chains in a market that sells substitutable items and
encounters inventory inaccuracy. Each supply chain is composed of one dominant sup-
plier and one exclusive retailer, as shown in Figure 1A (Appendix A in the Supplementary
Material). The two suppliers, that is, retailers and items, are indexed by i and j , where
i, j ∈ {1, 2} and i ≠ j . To save space, we summarize the demand function and related
assumptions in Appendix B (see the Supplementary Material).
Because of inventory inaccuracy, some inventory may not be available for sale dur-
ing the selling season. Following Camdereli and Swaminathan (2010), Fan et  al. (2015)
and Tao et  al. (2017), we define 𝜆 as the inventory availability rate, where 0 < 𝜆 ≤ 1 . It
is a deterministic and exogenous parameter in this paper that is determined by shrinkage
and/or misplacement in the supply chain. When 𝜆 = 1 , there is no inventory inaccuracy,
and the entire inventory can be used for sale during the entire selling period, which is the
common assumption in traditional inventory literature. When 0 < 𝜆 < 1 , inventory inac-
curacy occurs. Additionally, regarding lost inventory, if it is recovered at the end of the
selling season, typically, it can be processed in two ways. Some papers assume that the
recovered inventory is salvaged (Camdereli and Swaminathan 2010; Fan et al. 2015), but
some assume that it is worthless (Tao et al. 2019, 2020). We adopt the second assumption
because it is reasonable and prevalent in seasonable and/or perishable product industries
that obsolete items and/or damaged inventory cannot be sold and is therefore discarded.
Specifically, we assume that the order quantity is 10. Because of inventory inaccuracy, if
two of these items are missing (shrinkage or misplacement) and cannot be sold, the inven-
tory availability rate is 0.8 (= 8/10). At the end of the selling season, even if these two
items are found, because they are out of date and have no salvage value, they have no effect
on the sales decision and can be neglected.

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3.2 Centralized channel

In the centralized supply chain, both the wholesale price and consignment price the retailer
pays to the supplier can be considered as endogenous payments that do not influence order
quantities and retail prices. By contrast, the order quantity in the centralized supply chain is
determined centrally, independent of the contract format. Because of inventory inaccuracy,
when production/ordering quantity Q is placed, the available inventory for sale is 𝜆Q . The
detailed derivations of the solutions are presented in Appendix C (see the Supplementary
Material).
It is obvious that when a supply chain encounters inventory inaccuracy, both the stock-
ing factor and retail price are dependent on inventory availability. FWH and Adida and
Ratisoontorn (2011) illustrated that the optimal stocking factor and retail price are both
related to price sensitivity and the channel cost; however, when the supply chain is subject
to inventory inaccuracy, the decision variables additionally rely on inventory availability.
Thus, it is necessary to consider inventory inaccuracy when making decisions. According
to Proposition A1 (see the Supplementary Material), we derive the characteristics of the
optimal solutions as follows.

Proposition 1  In the centralized supply chain,

(1) the optimal stocking factor decreases as the inventory availability rate increases;
(2) the optimal retail price decreases as the inventory availability rate increases.

The detailed proof is included in Appendix E (see the Supplementary Material). From
Proposition 1, both the stocking factor and retail price decrease as inventory availability
decreases. It is intuitive that the amount of inventory for sale increases when inventory
availability increases such that the retail price and stocking factor decrease.

Proposition 2  The optimal expected profit in the centralized supply chain increases as
its inventory availability increases but decreases as the competitor’s inventory availability
increases.1

The proof is presented in Appendix E (see the Supplementary Material). The central-
ized supply chain can benefit from improving inventory availability, as more goods are
available for sale. The stocking factor and retail price both decrease as inventory availabil-
ity increases, which indicates that the sales increment caused by the increase of inventory
availability compensates for the decrement caused by the decrease of the retail price. Based
on these conclusions, the supply chain always benefits from inventory management per-
formance if performance can be calculated via inventory availability. However, when the
competitor’s inventory availability improves, more items are competing in the market such
that the retail price of the competitive supply chain decreases, which intensifies competi-
tion in the market. Therefore, its profit decreases.

1
  For ease of exposition, the corresponding retailer, supplier in one supply chain, and the supply chain itself
share the same inventory availability, although we assume that inventory inaccuracy occurs on the retailer’s
side.

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4 Decentralized supply chain

We consider two types of competition in decentralized supply chains: (1) horizontal

competition between two dominant suppliers; and (2) vertical competition between an
upstream supplier and a downstream retailer within one supply chain. We assume the
former to be non-cooperative, where the two dominant suppliers determine the contract-
ing strategies independently and simultaneously; and we assume that the latter follows
the Stackelberg game, where the dominant supplier determines the wholesale/consign-
ment price and the follower retailer, who suffers from inventory inaccuracy, chooses the
order quantity and retail price. Regarding the contracting strategies, we examine three
scenarios:

(1) Wholesale price contract: Both suppliers adopt the wholesale price contract.
(2) Consignment contract: Both suppliers use the consignment contract.
(3) Hybrid contract: One supplier uses the wholesale price contract and the other supplier
uses the consignment contract.

Additionally, in this paper, retailers in the supply chain suffer from inventory inaccu-
racy, which is different from the assumption that Camdereli and Swaminathan (2010) and
Fan et  al. (2015) made, as inventory inaccuracy typically occurs in retailing (Dehoratius
and Raman 2008). Therefore, the production quantity on the supplier’s side is equal to
the order quantity ( Qi ) from the retailer. Despite this, the available inventory ( 𝜆i Qi ) on the
retailer’s side is less than the order quantity because of inventory inaccuracy. To maintain
focus on the analysis, the detailed derivations of these three cases are shown in parts 2–4
of Appendix C and the corresponding proofs are summarized in Appendix E (see the Sup-
plementary Material).

4.1 Wholesale price contract

In wholesale price contracts, decisions are made in two sequential steps. In the first step,
the dominant suppliers simultaneously announce wholesale prices to downstream retailers
regardless of inventory inaccuracy on the retailers’ side; and in the second step, the cor-
responding retailers simultaneously determine the order quantities and retail prices before
demand is realized when suffering inventory inaccuracy. We use standard backward induc-
tion to obtain the equilibrium solutions.
Under the wholesale price contract, the optimal stocking factor and retail price are more
complex than they are in the centralized supply chain. Because the retailer is in charge of
the entire inventory and therefore takes on the entire risk of inventory inaccuracy in the
wholesale price contract, it is reasonable to consider inventory inaccuracy when determin-
ing the optimal order quantity (see Eq. 9). Furthermore, the wholesale price is related to
inventory inaccuracy. This effect is indirectly transferred to the determination of the retail
price, even though the impact of inventory inaccuracy on the retail price is directly and
clearly observed in Eq. 10. The equations demonstrate that the stocking factor (retail price)
decreases (increases) as the wholesale price decreases (increases); however, the monoto-
nicity between inventory inaccuracy and the stocking factor and retail price is not easily
observed because the correlation between inventory inaccuracy and the wholesale price is
not clear.

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Although it is infeasible to obtain an explicit function for the wholesale price that results
from the complexity of the stocking factor, the following conclusions can be derived.

Proposition 3  Under the wholesale price contract,

(1) the optimal stocking factor decreases as inventory availability increases;

(2) the optimal wholesale price increases as inventory availability increases; and
(3) the optimal retail price decreases as inventory availability increases.

Clearly, both the stocking factor and retail price decrease as inventory inaccuracy
increases, which is similar to the corresponding correlation in the centralized supply chain.
Under the wholesale price contract, the retailer retains ownership of the inventory such
that more goods are available for sale as inventory availability increases, even though the
stocking factor decreases as inventory availability increases. For example, assume that six
items are needed to satisfy demand. If inventory availability is 𝜆i = 0.6 , the retailer has to
order 10 items; and when inventory availability increases to 0.8, ordering eight items is
sufficient. As such, the supplier has the incentive to increase the wholesale price. How-
ever, for the retailer, because more inventory is available to sell when inventory availability
increases, to attract demand, it is beneficial to decrease the selling price. This observation
indicates that the supplier benefits from the performance of inventory management on the
retailer’s side, although it does not take on any of the risk caused by inventory inaccuracy.
In terms of profit, we present the following proposition.

Proposition 4  The retailer’s optimal expected profit increases as its inventory availabil-
ity increases but decreases as the competitor’s inventory availability increases.

Because of the complexity of the supplier’s optimal objective function 𝜋SDW  , it is intrac-
i
table to verify the monotonicity of this function with respect to inventory availability 𝜆i .
Thus, we leave this discussion for the following numerical study. The retailer benefits from
inventory availability because the growth of sales can offset the increment of the wholesale
price payment. Therefore, improving the performance of inventory management from the
retailer’s side is beneficial for the retailer.

4.2 Consignment contract

Under the consignment contract, the decision sequence is similar to the case for the whole-
sale price contract, except that the dominant suppliers simultaneously announce the con-
signment price in the first step. In the second step, the corresponding follower retailers that
are subject to inventory inaccuracy simultaneously determine the order quantities (stocking
factors) and optimal retail prices to maximize expected profits. Analogously, we use back-
ward induction to determine the equilibrium solutions.

Proposition 5  Under the consignment contract,

(1) the optimal stocking factor decreases as inventory availability increases;

(2) the optimal consignment price decreases as inventory availability increases;
(3) the optimal retail price decreases as inventory availability increases.

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When the consignment contract is used, all three decision variables decrease as inven-
tory availability increases. Under this contract, the risk of inventory inaccuracy is shared
between the supplier and retailer. Because of inventory inaccuracy, the supplier takes on
the risk of losing the consignment price ( wDCi
 ) per unit of lost inventory, and the retailer
bears the risk of losing the revenue ( pDC
i
− w DC
i
 ) per unit of lost inventory. Because the
supplier retains ownership of all inventory in a consignment contract, and payment is
transferred from the retailer to the supplier only after the product is sold, the increment of
sales contributed by the improvement of inventory availability encourages the supplier to
reduce the wholesale price, and this further drives the retailer to reduce the retail price. We
assume that inventory inaccuracy occurs on the retailer’s side; therefore, the decrement of
the consignment price can be considered as an incentive for the retailer to improve inven-
tory management.

Proposition 6  The optimal expected profit under the consignment contract 𝜋SDC(𝜋RDC )
i i
increases as supply chain i’s inventory availability increases but decreases as supply chain
j’s inventory availability increases.

Given the consignment contract, from Proposition 5, we know that when inventory
availability increases, both the consignment price and selling price decrease. There are two
effects: (1) the decrement of price; and (2) the increment of sales. Note that the supplier
retains ownership of the inventory. Thus, when more inventory (because inventory inaccu-
racy decreases) is available for sale, the supplier has the incentive to decrease the consign-
ment price to induce the retailer to decrease the selling price, which stimulates demand.
Under this condition, the net increase in sales totally overwhelms the net decrease in not
only the consignment price, but also the selling price. Finally, both the supplier and retailer
benefit from the increase of inventory availability.
Comparing the stocking factors in the three scenarios leads to the following conclusion:

Proposition 7  Given inventory inaccuracy, the stocking factors satisfy

zDW C DC
i,𝜆 < zi,𝜆 ≤ zi,𝜆 .
i i i

This proposition is similar to Proposition 9 in FWH’s work. The main difference is that
we consider inventory inaccuracy when determining the optimal stocking factor. If the
inventory is accurate ( 𝜆i = 1 ), it is identical to FWH’s conclusion. Therefore, this proposi-
tion can be seen as an extension of FWH’s proposition that covers inaccurate inventory in
the supply chain.

Proposition 8  When the retailer takes the whole channel cost, if the inventory availabili-
ties under the consignment contract and centralized supply chain are equal, the optimal
retail prices satisfy pDC
i
> pCi.

This proposition demonstrates that provided the performance of inventory management

in the centralized supply chain is as good as that in the decentralized supply chain with
the consignment contract, consumers are better off in the centralized supply chain (lower
selling price). By contrast, from Proposition 5, we know that the selling price in the con-
signment contract decreases as inventory availability increases, which also indicates that if
the supplier (owner of inventory) and retailer (executor of operations) could cooperate to

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manage the inventory and increase inventory availability, the selling price may be lower in
the decentralized supply chain than in the centralized supply chain such that consumers are
better off in the consignment contract, even if the retailer is responsible for the entire chan-
nel cost.

4.3 Hybrid scenario

In the hybrid scenario, one supply chain uses the wholesale price contract, and the other
supply chain uses the consignment contract. Both supply chains encounter inventory inac-
curacy on the retailer’s side.

5 Numerical study

In this section, we conduct an intensive numerical study to investigate the impact of inven-
tory inaccuracy on the profits of retailers, suppliers, and supply chains, and on contracting
strategies under the wholesale price contract and consignment contract. All the figures are
presented in Appendix D (see the Supplementary Material).
To derive the analytical results, we assume that 𝜀 ∼ U(0, 2) . Without loss of generality,
we fix “a” at 10 and c = 1 . The inventory availability 𝜆 ∼ U(0.1, 1) with 21 discrete values
means that inventory inaccuracy follows U(0.9, 0) with 21 discrete values. Additionally,
we assume that the stochastic term 𝜀 is uniformly distributed within the range (0, A) for
A = 1, 2, 5, 10, 100. We additionally validate the conclusion using a normal distribution
with mean values 𝜇 = 1, 2, 10 and standard deviations 𝜎 = 𝜇∕3, 𝜇∕5, 𝜇∕10 . Because we
observe no qualitative difference using a more general distribution, we select the uniform
distribution where A = 2 as a representative example to illustrate the solutions in various
scenarios. All the data and computer programs (written in MATLAB 2010a) are available
upon request.

5.1 Sensitivity analysis

To explicitly show the impact of inventory inaccuracy on the decision variables, we assume
that the cost structures of the two supply chains satisfy 𝛼i = 𝛼j ; we fix the inventory avail-
ability of supply chain i at 𝜆i = 0.6 ; and then we increase the inventory availability of sup-
ply chain j from 0.1 to 1 with 21 discrete values. The wholesale/consignment prices, retail
prices, and stocking factors are correlated in the two competing supply chains, and thus we
summarize these decisions in Figure 2A.
Figure 2A shows that the optimal wholesale/consignment prices, retail prices, and stock-
ing factors are all independent of the competitor’s inventory availability, but they depend
on each chain’s inventory availability, which we proved in Propositions 3 and 5. From the
figure, we derive the following conclusion.

Observation 1  wDC and pDC > pCi for any

( HC ) ( HW ) ( HC ) ( HW )
i
wi > wDW
i
wi i
pi > pDW
i
pi
given inventory availability 𝜆i.

This conclusion is an extension of Observation 2 in FWH’s work. In addition to the

reason given by FWH, in the consignment contract, the supplier also shares some inventory

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inaccuracy risk with the retailer. Taking on more risk further aggravates the rise in the con-
signment price.
The effect of inventory availability on operational decisions (i.e., pricing and order
quantity) further influences the optimal profits, which is illustrated in Figure 3A. The figure
clearly shows Observation 2.

Observation 2  Under the wholesale price contract, the supplier’s profit 𝜋SDW increases
i
as its inventory availability 𝜆i increases and decreases as the competitor’s inventory avail-
ability 𝜆j increases.

Although the intractability of the wholesale price under the wholesale price contract
leads to the infeasibility of determining the monotonicity of the supplier’s optimal profit,
the numerical results explicitly demonstrate the characteristics of this objective function.
Thus, we conclude that improving the performance of inventory management on the retail-
er’s side not only benefits both the retailer and supplier in both the wholesale price contract
and consignment contract, but also increases the supply chain’s capability in the competing
market.2 According to this observation, we boldly deduce that the performance of inven-
tory management is also a determinant factor to improve competitive power.
In this context, the supplier is the leader in the chain-to-chain competition, and it has the
authority to offer a contract format based on its expected profit. Because inventory inac-
curacies in the two supply chains may differ from each other, and because the contracting
strategy in one supply chain may be affected by the inventory inaccuracy of the competitive
supply chain, to characterize the optimal contract format subject to inventory inaccuracy,
we change the inventory availability of the two supply chains from 0.1 to 1 with 21 discrete
values. Importantly, we investigate the impact of a supply chain’s inventory availability
and a competitor’s inventory availability on the supplier’s expected profit. A representative
example is shown in Figure 4A (see the supplementary material).
Figure  4A shows that the supplier’s maximum expected profit is determined not only
by the supply chain’s inventory availability, but also the competitor’s inventory availabil-
ity. This observation encourages further investigation of contracting policy under different
scenarios.
To clarify the impact of inventory inaccuracy on the equilibrium contracting policy in
two competing supply chains, we categorize the numerical study into two subcases: (1) the
symmetric case, where the cost structures in both supply chains are the same; and (2) the
asymmetric case, where the cost structures in the two supply chains are different. By con-
trast, Adida and Ratisoontorn (2011) and FWH subjected the equilibrium solutions to sup-
ply chain competition and the channel cost-sharing rate between the supplier and retailer.
To capture this property, we investigate intense competition versus mild competition and
the different channel cost-sharing rates in each subcase.

5.2 Symmetric case

As stated in Adida and Ratisoontorn (2011) and FWH, price sensitivity, demand substitu-
tion, and the channel cost-sharing rate are the key factors in determining the contracting

2
  The supply chains’ profits increase as inventory availability increases; we do not present this here to save
space.

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 Annals of Operations Research

strategy in two competing retailers or supply chains. To avoid the impact of these param-
eters on contracting policy, and to focus on the effect of inventory inaccuracy on contract
adoption, we choose 𝛾 = 0.1 and 𝛾 = 1 as two types of competition. We set 𝛽 = 0.11 , 0.5,
1.0 when 𝛾 = 0.1 and 𝛽 = 1.1 , 5, 10 when 𝛾 = 1.0 to represent different price sensitivi-
ties. In each pair of competitions and price sensitivities, we predetermine 𝛼 = 0.125 and
𝛼 = 0.875 to represent the small and large share of the channel cost (retailer’s share) such
that there are 2 × 3 × 2 = 12 cases. In each case, we test the wholesale price contract sce-
nario, consignment contract scenario, and hybrid contract scenario sequentially. To exam-
ine the impact of inventory availability on the contracting strategy, we change the inventory
availability of both supply chains from 0.1 to 1 with 21 discrete values such that the output
contains 21 × 21 = 441 values in each contract scenario. The numerical results are sum-
marized in Figs. 1 and 2.
From Figs. 1 and 2, it is clear that inventory inaccuracy plays an important role in deter-
mining the optimal contract format. The text in the figures is the contracting strategy for
both suppliers; the symbol in parenthesis under the text represents the best contract formats
for the two supply chains for one supplier. For example, in the bottom left corner of Fig. 1,
competition is mild ( 𝛾 is small) and the channel cost-sharing rate is small. Regardless of
the inventory inaccuracy of supplier i and supplier j and regardless of the contract for-
mat the other supplier chooses, the optimal contract format for the supplier ( i or j ) is the
wholesale price contract. However, if the competitor changes the contract format to the
consignment contract, the supplier’s profit increases. Generally, the equilibrium contract-
ing strategies can be summarized as follows:

(A) When the competition is mild (small 𝛾  , Fig. 1), the contracting strategy in this sce-
nario can be categorized into two subcases with respect to the channel cost-sharing rate.
(A1) If the supplier takes more of the channel cost (small 𝛼 ) and price sensitivity is
large ( 𝛾 ∕𝛽 → 0 ), regardless of the values of its own or the competitor’s inventory
availability, the wholesale price contract is always the optimal contract format for the
supplier. FWH explained that large own-price sensitivity leads to lower demand, and
further reduces revenue. In this paper, we find that, for a certain supply chain (e.g., sup-
ply chain i), the increase of its own inventory availability increases its profit, and the
increase in the competitor’s inventory availability decreases its profit (Propositions 4
and 6, and Observation 2). In this scenario, the wholesale price contract is optimal, as it
eliminates inventory risk and lowers demand from the supplier. However, when the own
price sensitivity is small ( 𝛾 ∕𝛽 → 1 ), there is a threshold value of own inventory avail-
ability 𝜆∗i such that if inventory availability satisfies 𝜆i < 𝜆∗i  , the wholesale price contract
is the optimal contract; and if 𝜆i > 𝜆∗i  , the consignment contract is the optimal contract.
In this case, both 𝛽 and 𝛾 are small such that the retail price has little effect on demand.
Inventory inaccuracy becomes a key factor in the decision. When own inventory avail-
ability is small, the supplier bears a lower risk of inventory inaccuracy if it chooses
the wholesale price contract; and when inventory availability is large, the inventory risk
is low. Furthermore, the retail price in the consignment contract is larger than that in
the wholesale price contract, but the consignment wholesale price decreases rapidly as
inventory availability increases (see Figure 2A in the Supplementary Material). There-
fore, the supplier makes more profit from the consignment contract.
(A2) If the supplier takes a small part of the channel cost (large 𝛼 ), and its own price
sensitivity is large ( 𝛾 ∕𝛽 → 0 ), there is a threshold value of inventory availability 𝜆∗i  .
If 𝜆i < 𝜆∗i  , the supplier chooses the wholesale price contract; and if 𝜆i > 𝜆∗i  , the sup-
plier chooses the consignment contract. Because the retailer is in charge of all inven-

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Annals of Operations Research

tory under a wholesale price contract, when inventory availability is small, the retailer
bears much more inventory risk than the supplier (inventory inaccuracy risk transfers
to the supplier via both the demand and retail price). Thus, it is better for the dominant
supplier to choose the wholesale price contract. However, when inventory availability
increases, inventory inaccuracy risk reduces. Furthermore, the larger the channel cost-
sharing rate, the lower the stocking factor (see Eq. (19) and the proof of Proposition 1
in the Supplementary Materials), and the retail price under the consignment contract
is higher than that under the wholesale price contract (see Observation 1). Hence, it is
beneficial to shift to the consignment contract. Despite this, when supply chain i’s own
price sensitivity is small ( 𝛾 ∕𝛽 → 1 ), supplier i always chooses the consignment contract.
This is because, in this subcase, the retailer takes most of the channel cost, and when a
wholesale price contract is adopted, the retailer would quit the chain if it additionally
suffered from serious inventory inaccuracy.
(B) When the competition is intense (large 𝛾  , Fig. 2), in this case, the product is more
substitutable. The contracting strategy is also related to inventory inaccuracy and can be
divided into two subcases according to the channel cost-sharing rate.
(B1) If the supplier shares more of the channel cost (small α), it would like to reduce
inventory inaccuracy risk by passing it down to the retailer. Additionally, intensify-
ing competition (large γ) would decrease demand and, in turn, the supplier’s profit.
Although we have demonstrated that high inventory availability increases the supplier’s
sales revenue under the consignment contract, this increment effect cannot alleviate the
loss that results from sharing more cost and/or decreasing demand. Consequently, the
wholesale price contract is the optimal choice.
(B2) If the supplier shares less of the channel cost (large α), it can benefit from a higher
consignment price under the consignment contract when its own price sensitivity is
large ( 𝛾 ∕𝛽 → 0 ). This is different from the previous corresponding condition when 𝛾
is small; even though large price sensitivity results in low demand, large substitutabil-
ity increases demand. Therefore, it is beneficial for the supplier to take on the inven-
tory inaccuracy risk together with the retailer because of the high consignment price.
By contrast, when its own price sensitivity is small ( 𝛾 ∕𝛽 → 1 ), demand is high. Thus,
even if inventory availability is low (i.e., 𝜆i < 𝜆∗i  ), it is beneficial to choose the whole-
sale price contract to achieve a steady profit. However, when 𝜆i > 𝜆∗i  , more inventory is
available for sale to increase revenue such that the supplier would prefer the consign-
ment contract and share the inventory inaccuracy risk with the retailer.

To summarize, under the subcases in which inventory availability plays a role in deter-
mining the optimal contract format in the symmetric system, the strategies shift from the
wholesale price contract to the consignment contract when the own inventory availability is
larger than a threshold value. This is mainly because when inventory availability is small,
the supplier bears less inventory inaccuracy risk in a wholesale price contract, in which its
profit is mostly dependent on order quantity. However, when inventory availability is large,
the supplier can benefit more from the expected sales in a consignment contract rather than
the order quantity in a wholesale price contract, even if it shares inventory inaccuracy risk
with the retailer.
It is worth noting that, based on our assumptions and tests, the equilibrium contracting
strategy in the upper right section of Fig. 1 is a consignment contract. Moreover, one sup-
plier’s optimal contract format is also the favorite contract format for the other supplier;
that is, in these areas, the consignment contract simultaneously maximizes the two suppli-
ers’ profits. By contrast, in the leftover areas (including Figs. 1, 2), although both suppliers

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 Annals of Operations Research

choose the same equilibrium contracts, one of them would be better off if the other supplier
moved from the equilibrium contract to an alternative contract.
An intriguing observation from the numerical study is that, when considering inven-
tory inaccuracy in competing supply chains, the decentralized supply chain does not nec-
essarily underperform the centralized supply chain. Independent of competition, when its
own inventory availability is low, under both the wholesale price contract and consignment
contract, the decentralized supply chain overwhelmingly outperforms the centralized sup-
ply chain (see Figure 5A). FWH contributed the outperformance of the decentralized sup-
ply chain to the intensifying horizontal competition (i.e., 𝛾∕𝛽 → 1 , see Figure 5A-[a]). Our
work enriches the conclusion of FWH since we observed that the statement that the decen-
tralized supply chain outperforms the centralized supply chain is also valid when 𝛾∕𝛽 → 0
(see Figure  5A-[b]) under the condition that the two competing supply chains encounter
inventory inaccuracy.

5.3 Asymmetric case

In this subsection, we investigate the impact of inventory inaccuracy on the equilibrium

contracting strategy when the cost structures of the two supply chains are different. Simi-
lar to Adida and Ratisoontorn (2011), without loss of generality, we let 𝛼1 = 0.125 and
𝛼2 = 0.875 . The other parameters take the same values as those in the symmetric case.
Analogously, we fix one of the inventory availabilities at 𝜆1 = 0.5 and 𝜆1 = 1.0 , and
change the other inventory availability from 0.1 to 1 with 21 discrete values. A representa-
tive example of the impact of inventory availability on the supplier’s profit is presented in
Figure 6A. After numerical study and summarizing the results, we obtain the equilibrium
contracting strategies in an asymmetric case, as shown in Fig. 3.
In contrast to the symmetric system, when horizontal competition is intense
(i.e.,𝛾∕𝛽 → 1 ), if the product is less substitutable (i.e., 𝛾 = 0.05 ), given inventory inaccu-
racy, although the wholesale price is lower than the corresponding consignment price, the
retail price has little effect on demand. Consequently, the supplier does not obtain more
expected revenue from a consignment contract. Hence, regardless of whether the supplier
is high-cost or low-cost, using the wholesale price to preserve the gross profit is always the
best choice. However, when the product is more substitutable (i.e., 𝛾 = 0.5 ), the high-cost
supplier (which takes on more of the channel cost) is willing to use the wholesale price
contract if its own inventory availability is small ( 𝜆i ≤ 𝜆∗i  ). This is because, under this con-
dition, it is not beneficial for the high-cost supplier to share the expected sales revenue with
the retailer; the high cost leads the supplier to opt for the wholesale price contract instead.
When inventory availability is high ( 𝜆i ≥ 𝜆∗i  ), more inventory can be used for sale such that
the consignment contract becomes profitable. By contrast, for the low-cost supplier ( (which
takes on less of the channel cost), despite the low order quantity (because Qi = y pi , pj ⋅ zi
)

and, pi increases and zi decreases as the retailer’s sharing cost increases), the substitution
effect is strong such that sharing the sales quantity benefits the supplier. Eventually, the
low-cost supplier always chooses the consignment contract.
When vertical competition is intense (i.e., 𝛾∕𝛽 → 0 ), if the product is less substitut-
able (i.e., 𝛾 = 0.05 ), the order quantity is small for the low-cost supplier. However, now
the substitution effect is too weak such that it is beneficial to use the wholesale price
contract to avoid inventory inaccuracy risk. Even though the order quantity is large for
the high-cost supplier, the inventory available for sale is small. The supplier also prefers
the wholesale price contract until the inventory availability improves to a certain level

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Annals of Operations Research

Fig. 1  Equilibrium contracting strategy in a symmetric case with inventory inaccuracy when γ is small

( 𝜆∗j  ), whereupon it is better off sharing the sales quantity in the consignment contract.
An interesting finding from this study is that both suppliers would choose the consign-
ment contract when the product is more substitutable (i.e., 𝛾 = 0.5 ). Under this con-
dition, because both the wholesale and consignment prices, in addition to the order
quantity, are all decreasing as their own price sensitivities increase (refer to FWH),
and because the wholesale price is lower than the consignment price, which stimulates
demand and further increases the order quantity, it is beneficial for both suppliers to
use the wholesale price contract. It is necessary to note that when 𝛽 = 1 is chosen, the
contracting strategies in 𝛾∕𝛽 → 0 and 𝛾∕𝛽 → 1 are both the hybrid contract, which is
consistent with FWH for the same reasons. Thus, we do not present them in the figures.
To summarize, in the asymmetric case, in addition to competition, the equilibrium
contract relies on the trade-off between inventory inaccuracy risk and channel cost. We
can see that the equilibrium contracting strategy in the asymmetric case is almost com-
pletely different from that in the symmetric case. Specifically, in the symmetric case, if
cross-price sensitivity is small, in most cases, it is optimal for both suppliers to choose
the wholesale price contract when inventory availability is low, and choose the consign-
ment contract when inventory availability is high. However, if cross-price sensitivity is
large, the consignment contract is almost the best choice under the condition that the
supplier shares less channel cost. In the asymmetric case, however, in most cases, the
high-cost supplier prefers the wholesale price contract to avoid inventory inaccuracy

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 Annals of Operations Research

Fig. 2  Equilibrium contracting strategy in a symmetric case with inventory inaccuracy when γ is large

risk, and the low-cost supplier prefers the consignment contract to share the expected
sales quantity.
Similarly, we also investigate channel performance in the asymmetric supply chains sub-
ject to inventory inaccuracy (Figure 7A). Regardless of whether horizontal or vertical com-
petition is intense, we find that the decentralized chain outperforms the centralized supply
chain when inventory availability is below a threshold value. Together with the observation
in the symmetric supply chain, it is important to note that, in supply chains selling perish-
able products, such as seafood, vegetables, and fresh fruits, integrating the supply chain is
not always a good way to improve its profitability. Instead, improving inventory availability
for sale needs to be prioritized.

5.4 Remarks

Our conclusion remains valid on the condition that inventory availabilities are equal in
different scenarios, although we intentionally do not emphasize this in the text. However,
inventory availability may be different in centralized and decentralized supply chains, in
addition to the different contract formats. Although inventory inaccuracy is assumed to
occur on the retailer’s side, when the supply chain is becoming centralized, the perfor-
mance of inventory management may be improved such that retail prices and stocking
factors decrease. Analogously, the supplier is also somewhat responsible for inventory

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Annals of Operations Research

Fig. 3  Equilibrium contracting strategy in an asymmetric case: 𝛼i = 0.125 and 𝛼j = 0.875

management under the consignment contract such that inventory availability in the con-
signment contract may be higher than that in the wholesale price contract. Considering this
difference, equilibrium contracting strategies, in addition to optimal ordering and pricing
decisions, will definitely change. Despite this difference, in the current version, we demon-
strate the importance of inventory inaccuracy on contracting strategy, and operations deci-
sions in two competing supply chains such that asymmetric inventory availability exists is
left to further research.

6 Conclusion

We developed a newsvendor model to investigate equilibrium contracting strategies for two

competitive supply chains that are subject to inventory inaccuracy. We examined wholesale
price contract, consignment contract, and hybrid contract scenarios to analyze the impact
of inventory inaccuracy on (1) supply chain operational decisions, and (2) optimal contract
policy. We did this using both analytical results and an extensive numerical study.
In addition to the channel cost-sharing rate between the supplier and retailer, and
competition at horizontal and vertical levels, as illustrated in the literature, we found
that inventory inaccuracy is a necessary and important factor in determining the opti-
mal order quantity, retail price, and contract policy in supply chains. Specifically, under

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 Annals of Operations Research

the contract formats in this paper, the stocking factor, retail price, and consignment
price decrease (increase) as inventory availability (inaccuracy) increases. However, the
wholesale price increases as inventory availability increases. Analytically and numeri-
cally, profits increase as their own inventory availability increases but decrease as the
competitor’s inventory availability increases.
In terms of contracting strategies, for the symmetric settings, inventory inaccuracy
takes effect in the following three cases: (1) cross-price sensitivity is small, but suppliers
take on less channel cost, and vertical competition is intense; (2) cross-price sensitivity
is small, but suppliers take on more channel cost, and horizontal competition is intense;
and (3) cross-price sensitivity is large, but suppliers take on less channel cost, and hori-
zontal competition is intense. The optimal contracting strategies under these cases are
as follows: there are thresholds of inventory availability such that if the supply chain’s
inventory availability is below the threshold value, both suppliers prefer the wholesale
price contract such that the equilibrium contract policy is the wholesale price contract;
otherwise, if the supply chain’s inventory availability is above the threshold value, both
suppliers prefer the consignment contract such that the equilibrium contracting strategy
changes to the consignment contract. However, for the asymmetric settings, when cross-
price sensitivity is small and chain-to-chain competition is mild, there is a threshold of
inventory availability below which both suppliers prefer the wholesale price contract
such that the wholesale price contract is the equilibrium contracting strategy; otherwise,
the low-cost supplier has the incentive to change the contract type to the consignment
contract such that the hybrid contract is the equilibrium contract policy. Furthermore,
when cross-price sensitivity is large and chain-to-chain competition is intense, there is
a threshold value of inventory availability below which the high-cost supplier prefers
the wholesale price contract and the low-cost supplier prefers the consignment contract
such that the hybrid contract is the equilibrium contract policy; otherwise, the high-cost
supplier has the incentive to choose the consignment contract instead, and thus, the con-
signment contract becomes the equilibrium contracting strategy for both suppliers.
Traditionally, the consignment contract overwhelms the wholesale price contract in
chain-to-chain competition if the inventory is accurate. However, the conclusion is dif-
ferent if the inventory is inaccurate. Our research demonstrates that inventory inaccu-
racy needs to be considered carefully in operations decisions and, importantly, in con-
tract selection because inventory inaccuracy is prevalent in many industries, together
with the fact that the supplier may lose a great deal of profit if it fails to use the correct
contract format. Unfortunately, from the analysis, we know that it is infeasible to derive
the threshold values of inventory availability when determining the contract format,
which limits the application of our conclusions. Despite this, a simple strategy that will
be helpful for dominant suppliers is as follows: when the channel cost is symmetric,
choosing the wholesale price contract if inventory availability is low and choosing the
consignment contract if inventory availability is high mostly benefits suppliers; how-
ever, when the channel cost is asymmetric, it is almost beneficial for the high-cost sup-
plier to choose the wholesale price contract and for the low-cost supplier to choose the
consignment contract.
This work can be extended to consider asymmetric information between two supply
chains. Considering different inventory inaccuracies from the retailer’s side and sup-
plier’s side is also worthy of development. Finally, assuming stochastic inventory avail-
ability to examine the optimal operational decisions and equilibrium contract policy is
challenging but valuable future work.

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Annals of Operations Research

Supplementary Information The online version contains supplementary material available at https​://doi.

org/10.1007/s1047​9-021-03969​-6.

Acknowledgements  The authors are very thankful to the editor and the anonymous referees for their valu-
able suggestions to improve the quality of this paper. This paper was supported in part by National Natural
Science Foundation of China (No. 71872064, 72071137, 71671119), in part by Shanghai Pujiang Program
(18PJC025), in part by Qinglan Program of Jiangsu Province, and in part by the Fundamental Research
Funds for the Central Universities (JKN022023001).

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