Relational Supply Contracts: Voluntary Concessions in Return Policies for Continuous Quality Improvements

WHU Working Paper No. 2010-PROD-1

41 Pages Posted: 27 Apr 2011

Date Written: August 27, 2010

Abstract

Not every interaction within a supply chain is specified by a formal contract vetted by lawyers. Many things are agreed to on an informal basis and it is worth exploring how these informal side agreements relate to formal contracts. This paper studies a two-firm supply chain, where repeated transactions via well-established supply chain contracts and continued quality-improvement efforts are governed by a relational contract. We are able to characterize an optimal relational contract, i.e., to develop policies for supplier and buyer that structure investments in quality and flexibility in a way that no other self-enforcing contract generates higher expected joint surplus. For this purpose, we study an infinite horizon dynamic game with Markovian dynamics modelling the stochastic influence of the firms' actions on quality. We examine both quantity-based (quantity flexibility contracts) and price-based returns mechanisms (buy backs) and show that the rough equivalence between QF and buy-back contracts in the one period newsvendor setting does not carry over to the more complex setting as regards the leeway for contract adaptation and the need for additional transfer payments.

Keywords: relational contract, supply chain contract, return policy, quantity flexibility contract, buy-back contract, quality-improvement efforts

JEL Classification: C73, L14, M11

Suggested Citation

Hoehn, Michaela Isabel and Huchzermeier, Arnd and Lariviere, Martin, Relational Supply Contracts: Voluntary Concessions in Return Policies for Continuous Quality Improvements (August 27, 2010). WHU Working Paper No. 2010-PROD-1, Available at SSRN: https://ssrn.com/abstract=1799298 or http://dx.doi.org/10.2139/ssrn.1799298

Michaela Isabel Hoehn

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany

Arnd Huchzermeier (Contact Author)

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany
+49-261-6509380 (Phone)
+49-261-6509389 (Fax)

HOME PAGE: http://www.whu.edu/prod

Martin Lariviere

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

HOME PAGE: http://operationsroom.wordpress.com/

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