Offshore & Onshore Contracts
30 Pages Posted: 31 Oct 2008
Date Written: 2005
We study the buyer-seller relationship in a supply chain from the perspective of quality. In particular, weexamine situations where quality levels of the product can be observed, yet, conformance cannot be enforcedunless the buyer engages in costly, legally-binding activity, which we call audit. We assume that the cost ofaudit is borne by the buyer.We examine three types of remedies that can be taken in case an audit confirms the existence of qualityproblems, namely â Full Rebate", â Compensate" and â Repair" contracts. Under the Full Rebate regime, theseller rebates the buyer the purchase price of defective units. Under the Compensate regime (ExpectationDamages), the buyer is compensated for his loss of profit due to defects. Finally, under the Repair regime(Specific Performance), the seller is made to repair all the defective units at his own expense. We examinethe effects of these contracts on the performance of the supply-chain, and point out the implications foroffshore and onshore supply networks, respectively.Our results indicate conditions where the buyer is not motivated to â squeeze" all the profits out of thesupply chain, even in a setting of complete information, and even if the relationship is short-term. We extendthe analysis to examine supply-chains which include more than one seller or buyer. Also, as part of theanalysis, we study a problem, which we call the â Crime and Punishment" problem that is interesting in itsown right.
Keywords: quality, audit, supply-chain, newsvendor
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