Using Advance Purchase Discount Contracts: Operational Cost, Cost Opacity, and Timing
31 Pages Posted: 12 Jan 2015
Date Written: May 14, 2014
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: Suggested Citation