Combining Price, Rebate and Returns in Retailer-Supplier Contracts

Chun-Hung Chiu

Sun Yat-sen Business School, Sun Yat-sen University, No.135, Xingang West Road,

Guangzhou, China, 510275.

Emails: zhaojx5@mail.sysu.edu.cn, chchiu2000@gmail.com

Tsan-Ming Choi[1]

Business Division, Institute of Textiles and Clothing, The Hong Kong Polytechnic University,

Hung Hom, Kowloon, Hong Kong.

Email: jason.choi@polyu.edu.hk

Christopher Tang

UCLA Anderson School, UCLA, Los Angeles, CA90095, USA;

Email: ctang@anderson.ucla.edu

 

First version: December 13, 2014. Revised: March 24, 2015. Sep. 22, 2015.

An invited paper for POM Review.

 

 

Retail supply chains may be inefficientl for two key reasons.  First, there is no central coordinator who can “dictate” the decision of each member because different members (e.g., upstream suppliers, downstream retailers, etc.) are separate entities.   Second, each supply chain member will select the decision that is best for itself and such uncoordinated decisions often lead to poor performance.

 

To improve the operational performance in a decentralized retail supply chain, different incentive mechanisms are needed to entice the different supply chain members to make ordering decisions that are good for the entire supply chain, thus achieving coordination (Chiu et al. 2011). For example, suppliers can attract the retailers order more by (1) accepting returns and (2) offering partial refund for their products under the returns policy (commonly seen in the publishing industry). They can also provide cash incentives to the retailers to push up the sales amount and also the ordering quantity under the rebates policy (exercised by companies such as Rolex, Xerox, etc).

 

It is known that either the returns policy or the rebates policy alone is sufficient to help coordinate the supply chain with inventory decisions. However, retail pricing is also a critical decision in retailing and when the underlying market demand depends on the retail price, a simple incentive contract such as rebate or returns does not necessarily improve supply chain performance. This observation has motivated us to explore other incentive contracts.  Consider the one adopted by Marathon Sports.

 

Marathon Sports is one of the largest sportswear chain-store retailers in Hong Kong. It sells multiple nationally branded sportswear and footwear products such as Nike or Adidas.  Different manufacturers offer different “target sales rebate” programs, each of which stipulates that, Marathon Sports would earn a sales rebate value for each item (approximately 1% to 1.5% of the wholesale price) only when the company’s sales volume exceeds a certain pre-specified sales target. Interestingly, at the same time, in order to reduce the risk of overstocking due to this class of target sales rebate programs, we learn that Marathon Sports can return some unsold items at the end of the season. Thus, in Marathon Sports’ case, the incentive contract includes not just the channel rebates, but also the returns policy.

 

Motivated by the observations of various retailing cases on companies such as Marathon Sports, we have found that the use of a sophisticated contract can enable a manufacturer to coordinate the pricing and ordering decisions along a decentralized supply chain so that the manufacturer can entice the retailer to make the right decision that is good for both parties.

 

We call this a Price, Rebate, and Returns (PRR) supply contract, combining the channel rebate contract, the returns contract, and the wholesale pricing contract. In fact, one can well-imagine that in order to coordinate the inventory decision, the supply chain requires the implementation of one incentive alignment contract and this is done by the returns policy (in which both the wholesale price and the refund rate for the returns are decisions). Since retail pricing is also a decision, there is a need to include another contract and hence the rebates contract plays the role. These contracts together form the PRR supply contract. Overall speaking, we find that the PRR contract is highly versatile. It provides enough degree of freedom for the seller (e.g. the manufacturer) and the buyer (e.g. the retailer) to negotiate on the right contractual terms which can coordinate the supply chain and satisfy each member’s own profit preference simultaneously.   More importantly, we find that the PRR contract can lead to a win-win situation. Figure 1 shows an illustration on the use of simple and sophisticated supply contracts.

 

Traditionally, both practitioners and researchers focus on the use of simple contracts for supply chain coordination.  However, with the advance of information technology and the stronger emphasis on supply chain integration and partnership, sophisticated contracts such as PRR have been implemented in practice.  Other companies should consider using more sophisticated contracts because they can improve the overall supply chain performance.  More importantly, they can facilitate a win-win situation, which is a great way to foster stronger partnerships among different supply chain members.

 

supply

Figure 1. Supply contracts: simple contracts vs. sophisticated contracts.

 

 

 

Reference

Chiu, C.H., T.M. Choi, C.S. Tang. Price, rebate, and returns supply contracts for coordinating supply chains with price dependent demands. Production and Operations Management, 20, 81-91, 2011.

[1] Corresponding author: Tsan-Ming Choi

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