Supply Chain Contract

Alok Raj

XLRI-Xavier School of Management

alokraj@xlri.ac.in

July 27, 2021

Alok Raj (XLRI) SCM July 27, 2021 1 / 20

 Expected Profit

Alok Raj (XLRI) SCM July 27, 2021 2 / 20

Expected Profit

Demand=N(µ=32000, σ=11000)
Unit cost =$10.9/jersey
Unit selling price= $24/jersey
cs = 24 − 10.9 = $13.1; ce = $10.9
CR= 13.1
24 = 0.5458
Q ∗ = 32000 + NORM.S.INV (CR) × 11000 = 33210
What about expected profit that Reebok will earn?

Alok Raj (XLRI) SCM July 27, 2021 3 / 20

Expected Profit

π(Q) = px + g (Q − x) − cQ for x ≤ Q
(1)
= pQ − B(x − Q) − cQ for x ≥ Q

E [π(Q)] = (p − c)E [Sale] − (c − g )E [ELI ] − BE [US] (2)

E [Sale] = E [x] (µ) − E [US] (Expected lost sales) (3)
E [ELI ] = Q − E [Sale] = Q − (E [x] − E [US]) (4)
Z ∞
E [US] = (x − Q)f (x) dx for x ≥ Q = σG (z)
Q

where G(z)=Expected lost sales. We can directly calculate from Excel

∗
function as: NORMDIST(z,0,1,FALSE)-z*NORMSDIST(-z). z = Q σ−µ D
D

Alok Raj (XLRI) SCM July 27, 2021 4 / 20

Expected Profit
Without salvage
Demand=N(µ=32000, σ=11000)
Unit cost =$10.9/jersey
Unit selling price= $24/jersey
cs = 24 − 10.9 = $13.1; ce = $10.9
CR= 13.1
24 = 0.5458
Q ∗ = 32000 + NORM.S.INV (CR) × 11000 = 33210
z = 33210−32000
11000 = 0.11
G (z) = NORMDIST (0.11, 0, 1, FALSE ) − 0.11 ∗
NORMSDIST (−0.11) = 0.3463
E [US] = σG (z) = 11000 × 0.463 = 3810
E [Sale] = 32000 − 3810 = 28190
E [ELI ] = Q − E [Sale] = 33210 − 28190 = 5020
E [π(Q)] = (24 − 10.90) × 28190 − (10.9 − 0) × 5020 − 0 × 3810
= 3, 14571
(6)
Alok Raj (XLRI) SCM July 27, 2021 5 / 20
Expected Profit
With salvage
Demand=N(µ=32000, σ=11000)
Unit cost =$10.9/jersey
g=$7.(Last two digit of your roll number)/jersey
B=0
Unit selling price= $24/jersey
cs = 24 − 10.9 = $13.1; ce = 10.90 − 7 = $3.9
CR=?
Q ∗ =?
z =?
G (z) =
E [US] =?
E [Sale] =?
E [ELI ] =?
E [π(Q)] =?
Alok Raj (XLRI) SCM July 27, 2021 6 / 20
 Supply chain co-ordination

Alok Raj (XLRI) SCM July 27, 2021 7 / 20

Swimsuit Production Problem

A company designs, produces and sells summer fashion items such as

swimsuits. About six months before summer the company must commit
itself to specific production quantities for all its products. Since there is no
clear indication of how the market will respond to the new designs, the
company needs to use various tools to predict demand for each design, the
plan production and supply accordingly. In this setting, the trade-off are
clear: overestimating demand customer demand will result in unsold
inventory, while underestimating customer demand will lead to inventory
stock outs and loss of potential customers. To assist management in these
decisions, the marketing department uses historical data from the last five
year and construct a probabilistic forecast of the demand for
swimsuits.This probabilistic forecast suggest that average demand is about
13000 units, but there is probability that demand will be either larger than
average or smaller than average. ( Reference : Designing and managing
the Supply Chain, Simchi-Levi et al 2018)

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Swimsuit Production-Data
This is one-supplier-one retailer supply chain structure problem.
Following information are given below
c = $35 : production unit cost
w = $80 : supplier wholesale price
p = $125 : retailer selling price
g = $20 : retailer salvage price
F = $100000 : Fixed cost incurred by supplier
The demand facing the supply chain is given below:
0.28
0.25 0.23
Probability

0.2 0.19
0.15
0.11 0.11
9.5 · 10−2
0.1
8000 10000 12000 14000 16000 18000
Unit Sales
Alok Raj (XLRI) SCM July 27, 2021 9 / 20
Swimsuit Production-Data

Demand Data and its probability in the Tabular form

X f (x) Σf (x)
8000 0.11 0.11
10000 0.11 0.22
12000 0.275 0.495
14000 0.225 0.720
16000 0.185 0.905
18000 0.95 1
µ = 13000 Σxf (x) = 13100
What are the expected optimal profits and order quantities for the
supplier, the retailer and the system?

Alok Raj (XLRI) SCM July 27, 2021 10 / 20

Wholesale price contract

Decentralized case
The retailer faces uncertain demand X with cumulative distribution
function FX and density function fX .
The retailer orders q (a decision variable) units from the supplier at
wholesale price w.
The retailer sells at retail price p per unit to customers.
The salvage price is g at the end of selling season.

w = 80 min(x, Q)
Supplier Buyer
c = 35 p = 125 s = 20

45
Cs = 125 − 80 = 45, Ce = 80 − 20 = 60, CR = 45+60 = 0.4285
From the table it lies between 10000,12000. We will take the
maximum. So Q ∗ =12000.

Alok Raj (XLRI) SCM July 27, 2021 11 / 20

Comparison between Wholesale price contract and
Centralized case

Profit in case of Wholesale price contract

Retailer’s and Supplier’s Profit we can calculate using Q ∗ as Given
below.
Expected Retailer’s profit=470700; Expected Supplier’s profit=440000;
Total supply chain profit=910700(Refer Excel)
Profit in case of Centralized case
45
Cs = 125 − 35 = 90, Ce = 35 − 20 = 15, CR = 45+60 = 0.8571
From the table it lies between 14000,16000. We will take the
maximum. So Q ∗ =16000
Retailer’s and Supplier’s Profit we can calculate using Q ∗ as Given
below.
Total supply chain profit=1010700(Refer Excel)

Alok Raj (XLRI) SCM July 27, 2021 12 / 20

Comparison between Wholesale price contract and
Centralized case

Total supply chain profit in wholesale price contract is 11.5 % less

than Centralized case.
This means the wholesale price contract is not efficient contact . Now
the question is: Is there anything that the retailer and supplier can do
to increase the profit of supply chain?
CR(Wholesale price) = cs c+c
s
e
= p−wp−w
+w −g
cs p−c
CR(Centralised) = cs +ce = p−c+c−g
CR(Centralised) = CR(Wholesale price); w = c
Does supplier accept the order?

Alok Raj (XLRI) SCM July 27, 2021 13 / 20

 Buy-back Contract

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Buy-back Contract

A buy-back contract (return policy) is a commitment by the supplier

to buy back unsold inventory of the goods at the end of the selling
season so as to induce the buyer to order more from the supplier
The contract is specified by three parameters (q;w;b), where b > g
The supplier charges the retailer $w per unit purchased, but pays the
retailer $b per unit for any unsold items.
We assume p > w > c > b > g
Retailer would be happy but what about supplier
cs p−w
CR(Buy − back contract) = cs +ce = p−w +w −b
cs p−c
CR(Centralised) = cs +ce = p−c+c−g
CR(Buy − back contract) = CR(Centralised)
p(c−g )
b = ( p−g
p−c ) × w − p−c

Alok Raj (XLRI) SCM July 27, 2021 15 / 20

Buy-back Contract

p(c−g )
b = ( p−g
p−c ) × w − p−c
c = $35;w = $80; p = $125; g = $20
Based on above values we can find the relationship between b and w
b = 1.167w − 20.833
w 40 60 80 100 120 125
b 28.83 49.17 72.50 95.83 119.17 125
Q ∗ = 16000; Expected Retailer’s profit=929625; Expected Supplier’s
profit=85925; Total supply chain profit=1015550(Refer Excel)
Issues
Supplier needs to develop effective logistics system to collect the items.
In case of competing products, retailer may put effort to sell those
products which are not under buy-back contract.

Alok Raj (XLRI) SCM July 27, 2021 16 / 20

 Revenue-sharing Contract

Alok Raj (XLRI) SCM July 27, 2021 17 / 20

Revenue sharing Contract

The supplier charges the retailer at a lower wholesale price w per unit
purchased, and the retailer gives 1 − R percent of his revenue to the
supplier.
The contract is specified by three parameters (q; w ; R) where
0<R<1
How to choose w and R to maximise the order quantity
cs Rp−w
CR(Buy − back contract) = cs +ce = Rp−w +w −g
cs Rp−c
CR(Centralised) = cs +ce = Rp−c+c−g
CR(Revenue sharing contract) = CR(Centralised)
p−g g (p−c)
R= p(c−g ) ×w − p(c−g )

Alok Raj (XLRI) SCM July 27, 2021 18 / 20

Revenue sharing Contract

p−g g (p−c)
R= p(c−g ) ×w − p(c−g )
c = $35;w = $80; p = $125; g = $20
Based on above values we can find the relationship between R and w
R = 0.056w − 0.96
w 40 35 30 25 20 15
R 1.25 1 0.72 0.44 0.16 -0.12
Q ∗ = 16000; Expected Retailer’s profit=507775; Expected Supplier’s
profit=507775; Total supply chain profit=1015550(Refer Excel)
Issues
Supplier needs to monitor buyer’s revenue-administrative costs.
In case of competing products, retailer may put effort to sell those
products which have higher profit margin.

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 The End

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