Execution Quality and Chargeback Penalties in Retail Supply Chains

45 Pages Posted: 30 Jul 2015 Last revised: 14 Sep 2018

See all articles by Nathan Craig

Nathan Craig

Ohio State University (OSU) - Fisher College of Business

Nicole DeHoratius

University of Chicago - Booth School of Business

Diego Klabjan

Northwestern University

Date Written: September 5, 2018

Abstract

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.

Suggested Citation

Craig, Nathan and DeHoratius, Nicole and Klabjan, Diego, Execution Quality and Chargeback Penalties in Retail Supply Chains (September 5, 2018). Chicago Booth Research Paper No. 15-28. Available at SSRN: https://ssrn.com/abstract=2637594 or http://dx.doi.org/10.2139/ssrn.2637594

Nathan Craig

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

Nicole DeHoratius (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Diego Klabjan

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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