Contract Preferences and Performance for the Loss-Averse Supplier: Buyback versus Revenue Sharing

Management Science, Vol. 62(6), September 2015

61 Pages Posted: 10 Aug 2017

See all articles by Yinghao Zhang

Yinghao Zhang

University of Cincinnati

Karen Lisa Donohue

University of Minnesota - Twin Cities - Carlson School of Management

Tony Haitao Cui

University of Minnesota - Twin Cities

Date Written: February 2, 2015

Abstract

Prior theory claims that buyback and revenue-sharing contracts achieve equivalent channel-coordinating solutions when applied in a dyadic supplier–retailer setting. This suggests that a supplier should be indifferent between the two contracts. However, the sequence and magnitude of costs and revenues (i.e., losses and gains) vary significantly between the contracts, suggesting the supplier’s preference of contract type, and associated contract parameter values, may vary with the level of loss aversion. We investigate this phenomenon through two studies. The first is a preliminary study investigating whether human suppliers are indeed indifferent between these two contracts. Using a controlled laboratory experiment, with human subjects taking on the role of the supplier having to choose between contracts, we find that contract preferences change with the ratio of overage and underage costs for the channel (i.e., the newsvendor critical ratio). In particular, a buyback contract is preferred for products with low critical ratio, whereas revenue sharing is preferred for products with high critical ratio. We show these results are consistent with the behavioral tendency of loss aversion and are more significant for subjects who exhibit higher loss aversion tendencies in an out of context task. In the second (main) study, we examine differences in the performance of buyback and revenue-sharing contracts when suppliers have the authority to set contract parameters. We find that the contract frame influences the way parameters are set and the critical ratio again plays an important role. More specifically, revenue-sharing contracts are more profitable for the supplier than buyback contracts in a high critical ratio environment when accounting for the supplier’s parameter-specification behavior. Also, there is little difference in performance between the two contracts in a low critical ratio environment. These results can help inform supply managers on what types of contracts to use in different critical ratio settings.

Keywords: supply contracts; buyback; revenue sharing; loss aversion; behavioral operations

Suggested Citation

Zhang, Yinghao and Donohue, Karen Lisa and Cui, Tony Haitao, Contract Preferences and Performance for the Loss-Averse Supplier: Buyback versus Revenue Sharing (February 2, 2015). Management Science, Vol. 62(6), September 2015. Available at SSRN: https://ssrn.com/abstract=2743182

Yinghao Zhang

University of Cincinnati ( email )

2529 Campus Green Dr.
Cincinnati, OH 45221
United States

Karen Lisa Donohue

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

Tony Haitao Cui (Contact Author)

University of Minnesota - Twin Cities ( email )

321 19th Ave S
Suite 3-150
Minneapolis, MN 55455
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
93
rank
271,832
Abstract Views
623
PlumX Metrics