Using Advance Purchase Discount Contracts: Operational Cost, Cost Opacity, and Timing

31 Pages Posted: 12 Jan 2015

See all articles by Wenjie Tang

Wenjie Tang

NUS Business School - Department of Decision Sciences

Karan Girotra

Cornell Tech; Cornell SC Johnson College of Business

Date Written: May 14, 2014

Abstract

Advance purchase discount (APD) contracts can incentivize a retailer to share demand information with a dual-sourcing wholesaler. We analyze such contracts in terms of three practical considerations that have previously been overlooked: the retailer’s operational cost of adopting an APD scheme, the wholesaler’s limited information about it, and the contract’s timing. The wholesaler’s limited knowledge of the retailer’s cost leads to a departure — from the normal “full observability” APD design — that is asymmetric and depends on the extent of unobservability; thus, if the uncertainty is small (resp., large) then the optimal discount is higher (resp., lower) than in the case of full observability. Finally, a wholesaler can adjust the contract’s timing to synchronize the supply chain to his benefit. An APD contract that ignores the retailer’s cost or the wholesaler’s uncertainty about it, or is implemented in a suboptimal sequence, will yield fewer benefits for the wholesaler and the supply chain. We offer a numerical illustration (calibrated on real industry data) establishing that, for a representative product, an APD contract can improve the wholesaler’s profit margin by as much as 3.5%.

JEL Classification: M1

Suggested Citation

Tang, Wenjie and Girotra, Karan, Using Advance Purchase Discount Contracts: Operational Cost, Cost Opacity, and Timing (May 14, 2014). Available at SSRN: https://ssrn.com/abstract=2547521 or http://dx.doi.org/10.2139/ssrn.2547521

Wenjie Tang (Contact Author)

NUS Business School - Department of Decision Sciences ( email )

15 Kent Ridge Drive
Mochtar Riady Building, BIZ 1 8-69
119245
Singapore

Karan Girotra

Cornell Tech ( email )

111 8th Avenue #302
New York, NY 10011
United States

HOME PAGE: http://www.girotra.com

Cornell SC Johnson College of Business ( email )

Ithaca, NY 14850
United States

HOME PAGE: http://www.girotra.com

Register to save articles to
your library

Register

Paper statistics

Downloads
28
Abstract Views
272
PlumX Metrics