Execution Quality and Chargeback Penalties in Retail Supply Chains
45 Pages Posted: 30 Jul 2015 Last revised: 14 Sep 2018
Date Written: September 5, 2018
Retailers procure inventory by placing purchase orders (POs) with suppliers. POs specify product price, quantity, quality, and delivery times as well as other aspects of the fulfillment process, such as carton labeling requirements and packaging formats. Retailers expect suppliers to adhere to fulfillment terms to enable supply chain optimizations, e.g., automation and pack-by-store product flows. When servicing an order, a supplier may fail to adhere to the fulfillment terms, thus committing a fulfillment error and triggering a chargeback penalty. Chargebacks reduce supplier revenues, transferring billions of dollars from suppliers to retailers annually. We collect supplier compliance manuals from 111 retailers to characterize fulfillment errors and chargeback penalties in practice. We find that the majority of chargeback penalties listed by retailers pertain to execution quality: i.e., aspects of the fulfillment process beyond product price, quantity, quality, and delivery time. The PO thus allows firms to contract for execution quality in addition to product price, quantity, and product quality. We study the cost to retailers of lapses in execution quality using a stylized model and find that common chargeback forms do not convey accurately the cost of execution quality errors from the retailer to the supplier. Moreover, we analyze a game between a retailer and a supplier wherein the retailer sets a chargeback policy and the supplier trades off among chargeback penalties, its own cost of execution quality, and its ability to raise its price. The analysis reveals the extent to which a supplier’s capabilities and pricing power impact the effectiveness of chargebacks. Given these findings, we discuss the importance of further research on incentives for execution quality within supply chains.
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