Optimal Long-Term Supply Contracts with Asymmetric Demand Information

Abstract

We consider a manufacturer selling to a retailer with private demand information arising dynamically over an infinite time horizon. Under a backlogging model, we show that the manufacturer's optimal dynamic long-term contract takes a simple form: in the first period, based on her private demand forecast, the retailer selects a wholesale price and pays an associated upfront fee, and, from then on, the two parties stick to a simple wholesale price contract with the retailer's chosen price. Under a lost sales model, we show that the structure of the optimal long-term contract combines a menu of wholesale pricing contracts with an option that, if exercised by the retailer, reduces future wholesales prices in exchange for an immediate payment to the manufacturer.

Keywords: supply chain contracting, dynamic information asymmetry, inventory, dynamic mechanism design

JEL Classification: D82, C73