Commitment-Penalty Contracts in Drop-Shipping Supply Chains with Asymmetric Demand Information

European Journal of Operational Research, Vol. 204, pp. 449-462, 2010

30 Pages Posted: 6 Feb 2008 Last revised: 4 Feb 2010

See all articles by Xianghua Gan

Xianghua Gan

Southwestern University of Finance and Economics (SWUFE) - School of Business Administration

Suresh Sethi

University of Texas at Dallas - Naveen Jindal School of Management

Jing Zhou

University of North Carolina (UNC) at Charlotte

Date Written: November 5, 2009

Abstract

We study a drop-shipping supply chain in which the retailer receives a customer's order and the supplier fills it. In such a chain, the supplier keeps inventory and bears inventory risks; the retailer focuses on marketing and customer acquisition, and forwards the orders to the supplier. The retailer usually has better customer demand information, and may send an over-estimated demand forecast to maximize her own interest, which may result in overstock for the supplier. On the other hand, since the retailer does not own inventory, the main concern of the retailer is that the acquired orders may not be fulfilled because of the supplier's shortage of stock. To cope with these challenges, we propose a menu of commitment-penalty contracts that can provide greater certainty of demand as well as greater certainty of supply. We focus our study in the asymmetric demand information case and we show that the supplier can obtain the retailer's demand information by offering a menu of commitment-penalty contracts. Under this mechanism, we find the solution that maximizes the supplier's expected profit.

Keywords: contracts, dropshipping, supply chain, asymmetric information, commitment-penalty contract

JEL Classification: C61, M11, D8

Suggested Citation

Gan, Xianghua and Sethi, Suresh and Zhou, Jing, Commitment-Penalty Contracts in Drop-Shipping Supply Chains with Asymmetric Demand Information (November 5, 2009). European Journal of Operational Research, Vol. 204, pp. 449-462, 2010. Available at SSRN: https://ssrn.com/abstract=1089828

Xianghua Gan

Southwestern University of Finance and Economics (SWUFE) - School of Business Administration ( email )

No.55 Guanghuacun Street
Chengdu, 610074
China

Suresh Sethi (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

800 W. Campbell Road, SM30
Richardson, TX 75080-3021
United States

Jing Zhou

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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