Why are Minimum Order Quantity Contracts Popular in Practice? A Behavioral Investigation
33 Pages Posted: 26 Apr 2018 Last revised: 18 Sep 2019
Date Written: September 17, 2019
Problem Definition: In theory, all coordinating contracts are equivalent, however, the minimum order quantity (MOQ) contract is observed to be more popular in practice. We seek to understand whether decision makers as suppliers can perform better with the MOQ contract and, if so, why? We also study whether MOQ is indeed the preferred contract when subjects are allowed to choose among coordinating contracts.
Academic/Practical Relevance: The behavioral operations management literature has established a tradeoff between complex coordinating and simple non-coordinating contracts. This paper fills a gap in the literature by studying whether and how the coordinating MOQ contract attenuates this tradeoff.
Methodology: First, we test whether subjects in the role of suppliers given only a single contract type can optimize its parameters. Second, we introduce treatments where subjects have access to a decision support tool designed to lessen complexity. Third, we introduce treatments where the coordinating contracts subject to demand risk are hedged such that risk is eliminated. Fourth, we introduce a novel experimental design
where, in each period, subjects choose both the type of contract to offer and the parameters of that contract.
Results: We find that (i) subjects perform significantly better with the MOQ contract compared to other coordinating contracts; (ii) this can be attributed to the differing cognitive burden induced by, and risk inherent in, the different contracts; (iii) risk can be decoupled from cognitive burden to shed light on how much of the performance gap could be attributed to each factor; and, (iv) subjects choose the MOQ contract more frequently over theoretically equivalent coordinating contracts.
Managerial Implications: We show that the tradeoff between efficiency and complexity can be mitigated by simpler yet efficient contracts. Investing in decision support systems can also mitigate this tradeoff, but doing so may be prohibitively costly for smaller firms and firms based in emerging markets. Hence, there is considerable benefit to identifying contractual mechanisms that ameliorate the adverse effects of complexity.
Keywords: Behavioral Operations, Contracts, Buyback, Revenue-sharing, Minimum Order Quantity
Suggested Citation: Suggested Citation