International Journal of Production Research, 2015

Vol. 53, No. 2, 488–510, http://dx.doi.org/10.1080/00207543.2014.955219

Service capability procurement decision in logistics service supply chain: a research under
demand updating and quality guarantee
Weihua Liu*, Dong Xie, Yang Liu and Xiaoyan Liu

School of Management, Tianjin University, Tianjin, China

(Received 17 December 2013; accepted 10 August 2014)

Though existing researches have already studied on service quality guarantee and demand updating in a supply chain
respectively, there is little attention paid to integrated research on service quality guarantee problem with demand updat-
ing. This paper aims to investigate the impacts of demand uncertainty revelation and quality guarantee change cost
(GCC) on the optimal decisions of logistics service integrator (LSI) and functional logistics service provider (FLSP) in a
logistics service supply chain. At the beginning of the first period, the FLSP first guarantees an initial quality level and
the LSI procures service capacity from the FLSP based on the demand prediction. Then the demand information is
updated after the first-period demand being satisfied, and the LSI and the FLSP make their optimal decisions based on
the renewed demand in the next period. Before the second period, uncertainty complete revelation/uncertainty incomplete
revelation (UCR/UIR) and GCC/no guarantee change cost (NGCC) may take place, which will affect the decisions the
LSI and the FLSP make. Consequently, four situations are considered: (1) UCR and GCC; (2) UIR and GCC; (3) UCR
and NGCC; and (4) UIR and NGCC. In each situation, we derive the optimal decisions of the FLSP and the LSI, and a
comparison between the first- and second-period decisions in each situation is conducted. Several managerial insights are
concluded, and the most important one is that the LSI is supposed to reduce the procurement quantity and the FLSP is
supposed to promise a higher quality defect rate in the case of UIR and NGCC. Furthermore, in case of UIR and GCC,
we specify a critical condition in which the LSI and the FLSP insist on the initial decisions of the first period. At last,
we conducted numerical analysis and gave a practical example of China Yuantong Express Company to support our
conclusions.
Keywords: service quality guarantee; capacity purchase; logistics service supply chain; demand updating

1. Introduction
Service quality guarantee is an effective strategy to attract customers (So and Song 1998). A number of service-oriented
companies adopt this strategy to provide customers with qualified service. For instance, TNT promises ‘next day parcel
delivery’ to compete for a greater share of market. When facing deterministic quality-dependent demand, the decision-
makers just need to procure the corresponding quantity of service capacity once a quality guarantee is given, as assumed
by Liu and Xie (2013). However, the market demand is characterised by randomness. To reduce the cost of shortage or
surplus of stock resulting from demand uncertainty, historical sales data and sales information at hand are usually
referred to, i.e. update the demand information (Fisher and Raman 1996). It is critical for decision-makers to design an
adequate procurement plan for service capacity. Consequently, taking these two factors (service quality guarantee and
procurement quantity of service capacity) into consideration is imperative and practical.
This paper is aimed at investigating the optimal decisions of the service quality guarantee level and the procurement
quantity of service capacity. Comparisons are conducted to discover the changes of these two kinds of decisions after
demand updating in a quality-sensitive logistics service market. From the theoretical perspective, though existing
researches have already studied on service quality guarantee and demand updating in a supply chain, respectively, there
is little attention paid to integrated research on service quality guarantee problem with demand updating. Besides,
Larsen, Morecroft, and Thomsen (1999) have already proved that researches on this area are of great significance to
improve supply chain members’ decisions under more complex environment. From the practical perspective, this paper
is partly motivated by the state of chaos in the service providing mechanism of logistics enterprises during the online
promotion season. For instance, on 11 November 2011, with the guarantee as before that packages should be delivered
to customers in 31 provinces of China in 3–5 days, Yuantong Express Company was stuck with more than 2.67 million
packages from Taobao, which was more than four times as many as the number on the same day in 2010 (Zhang and

*Corresponding author. Email: lwhliu888@163.com

© 2014 Taylor & Francis

 International Journal of Production Research 489

Xiao 2011). Such problems as ‘warehouse explosion’, delayed delivery and cargo damage exploded. In such case, the
problems urgent to be solved by Yuantong are how to properly set the quality guarantee level and prepare adequate
quantity of service capacity. The problems are more complicated and practical in nature if multi-period cooperation is
considered.
To solve the problems above, quite a few logistics enterprises in China collaborate with each other to serve custom-
ers as an alliance, and thereby a logistics service supply chain (LSSC) is formed. The basic structure of a LSSC is from
functional logistics service provider (FLSP) → logistics service integrator (LSI) → manufacturers or retailers (Liu, Xie,
and Xu 2013). FLSPs refer to traditional third-party logistics firms such as transportation enterprises and storage enter-
prises. The FLSPs supply logistics capacity with guaranteed quality to the LSI that in turn sells the integrated logistics
services to the market. Baogong Logistics Company in China, for instance, integrates more than 500 warehousing pro-
viders, more than 1200 highway transportation providers and more than 500 loading and unloading companies. With
these FLSPs, Baogong provides comprehensive logistics services to several famous manufacturers, such as Procter &
Gamble and Unilever.
In this paper, a LSSC consisting of one FLSP and one LSI is considered. We investigate a two-period situation
(multi-period demand updating could be actually regarded as a repetition of two-period cycle). The market demand is a
quality-guarantee-sensitive stochastic variable. At the beginning of the first period, the FLSP first guarantees an initial
quality level and the LSI procures a service capacity from the FLSP based on the demand prediction. The LSI obtains
demand updating information after the first-period demand is satisfied and shares it with the FLSP, based on which the
LSI and the FLSP determine their optimal strategies in the next period. Before the second period, the updated demand
may turn up uncertainty complete revelation or uncertainty incomplete revelation (UCR/UIR) and the FLSP may suffer
from guarantee change cost or no guarantee change cost (GCC/NGCC) if it changes its initial guarantee level. Hence,
four possible scenarios could be obtained from a simple combination of the possible situations mentioned above and
they affect the second-period decisions of the LSI and the FLSP. This paper focuses on the optimal decisions of the
FLSP and the LSI under each of the four scenarios. By a comparison of the decisions between the first and second per-
iod, we also seek to answer the following questions and thereby provide tactical and managerial insights for managers:

What is the effect of demand revelation and guarantee change cost on the decision of procurement quantity
and quality guarantee level?

In what kinds of conditions should the firms alter their initial policies and when to implement consistent
policies in this quality-guaranteed system and demand revelation?
This paper is organised as follows: Section 2 reviews previous relative researches. In Section 3, the profit functions
and the optimal decisions of each LSSC member are presented with NGCC. A further discussion about the optimal deci-
sions is made with GCC in Section 4. Numerical analysis is conducted in Section 5. Section 6 summarises main conclu-
sions and expounds their management insights, and further Section 7 gives a practical example of Yuantong Express
Company in China. Section 8 points out some limitations of this paper and presents some directions for future work.

2. Literature review
The literature review is focused on these three aspects: (1) supply chain member decision-making with demand informa-
tion update; (2) service quality guarantee in a service supply chain; (3) capacity purchase decisions in a service supply
chain.

2.1 Decisions with demand information updating

Decision problems with demand information updating are widely explored, including the optimisation of ordering strat-
egy, contract design to coordinate the supply chain and the improvement of production or inventory with demand updat-
ing, etc. Common approaches dealing with demand updating adopted by these papers are Bayesian updating method
(Berk, Gürler, and Levine 2007; Song et al. 2014), Conditional distribution method (Iyer and Bergen 1997; Zhang,
Shou, and Chen 2013), AR(1) process (So and Zheng 2003), etc. These approaches, especially Bayesian updating
method, could be used in this paper.
In the researches on ordering strategy, the existing literature about demand updating mainly aimed at perishable
goods such as newspapers, magazines, movies, food, medicine and fashion. Price, lead time and goods order quantity
were always treated as decision variables (Gurnani and Tang 1999; So and Zheng 2003; Sethi et al. 2007; Miltenburg
and Pong 2007a, 2007b). For example, Gurnani and Tang (1999) advised the retailer to resolve the problem of
two-period procurement strategy by updating demand information based on market signals. After the research proposed
490 W. Liu et al.

by Gurnani and Tang (1999), many scholars enriched this problem to more complex environment. So and Zheng (2003)
discussed the impact of forecast demand updating on retailer’s order quantity variability in a two-level supply chain.
They believed that the forecast demand updating will also increase the variability of the order quantities; especially
when the external demands are correlated. They used an AR(1) process to model the external demand, such that
demands between two successive time periods are correlated. The two-stage procurement problem was further investi-
gated with retailers permitted to purchase goods from external market (Sethi, Yan, and Zhang 2004) and constraining
the service level (Sethi et al. 2007). Miltenburg and Pong (2007a, 2007b) extended the problem to more products with
ability limit and without ability limit. In addition, some scholars studied procurement decision of multi-products in dou-
ble channels with demand information update. The most typical research is Song et al. (2014), they built a bi-level pro-
gramming model and developed a sequential algorithm solving for a linear approximation, using Bayesian rule to
update the demand information. These literatures mentioned above are all focused on the manufacturing products, ser-
vice especially logistics service procurement decision with updating demand is not considered at all. In addition, these
literatures also did not involve the factor that quality will affect demand in the model building. But service quality could
affect customer demand by means of service quality guarantee (Hays and Hill 2001), service quality assurance (Oliver
and Koeberg 2013), service quality information provision (Paulley et al. 2006), service quality experiences (Jin, Line,
and Goh 2013) and others. Since service quality guarantee is the widest used method among these methods (Hays and
Hill 2001), in this paper, we will consider service quality guarantee factor in service procurement model.
In the researches on contract design to coordinate the supply chain, quite a few scholars participated in designing
supply chain contracts and pointed out that when the market demand can be predicted, the suppliers and retailers per-
forming the appropriate contract can make the revenue of the supply chain realise the Pareto improvement (Donohue
2000). For example, Tsay (1999) and Milner and Rosenblatt (2002) designed a quantity flexibility contract that retailers
order goods before market demand is realised, and then it can be allowed to adjust the actual order quantity after the
market demand is realised. Huang, Sethi, and Yan (2005) study a two-stage purchase contract with a demand forecast
update using a dynamic programming formulation. They obtained optimal solutions for a class of demand distributions.
Considering a stochastic demand information update, Chen, Chen, and Chen (2006) focused on pricing and inventory
joint decision and designing the repurchase contract to share the market risk.
In the researches about the improvement of production or inventory with demand updating, there are also many
scholars who study on it. For example, Berk, Gurler, and Levine (2007) considered Bayesian updating of demand in a
lost sales newsvendor model with censored observations. Benjaafar, Cooper, and Mardan (2011) studied the impact of
imperfect advance demand information and updating on the production-inventory systems. They formulated the produc-
tion-control problem as a continuous-time Markov decision process and proved there is an optimal state-dependent
base-stock policy, where the base-stock levels depend upon the numbers of orders at various stages of update. Özen,
Sošić, and Slikker (2012) studied inventory pooling coalitions within a decentralised distribution system by demand
forecasts updating. Zhang, Shou, and Chen (2013) paper studies the problem of how to coordinate postponed product
differentiation and forecasts update to improve manufacturing efficiency. The demand updating process including two
levels of demand uncertainty is similar to that in Iyer and Bergen (1997).

2.2 Service quality guarantee in a service supply chain

Many practitioners and academics have advocated service guarantees as an approach to improve service quality (Hays
and Hill 2006). And most of the researches support a positive relationship between the presence of a service guarantee
and improved service quality (Wirtz 1998; Hays and Hill 2001). Many empirical investigations found that service guar-
antee strength was positively related to customer perceptions of service quality, customer satisfaction and loyalty (Hays
and Hill 2001; Sum and Lee 2002; Hays and Hill 2006). Generally, the guarantee behaviour of service quality has a
wide range, such as time guarantee (De, Ghosh, and Wells 1991; Palaka, Erlebacher, and Kropp 1998; Ray and Jewkes
2004), price guarantee (So 2000; Quan 2002; McWilliams and Gerstner 2006; Carvell and Quan 2008) and return of
goods guarantee (Moorthy and Srinivasan 1995; Suwelack, Hogreve, and Hoyer 2011). These studies support that
quality guarantee plays a role in customers’ demand, but how quality guarantee level works in a demand-updating
environment has not yet been explored.
Except for empirical investigation, a number of researchers used modelling methods and mathematically explored
the impact of service quality guarantee on supply chain performance. These researches admitted that the service quality
guarantee affects customer demand, but few explored the impact of demand information update on the behaviour of
service quality guarantee. For example, according to Kashyap (2001), a typical service guarantee policy includes two
elements: a meaningful promise of a certain service quality and a compensation or payout offer, but he didn’t reveal the
relationship between the service guarantee and demand information updating. Based on the quantitative model, which is
 International Journal of Production Research 491

the Economic Payout Model for Service Guarantees (EPMSG) proposed by Baker and Collier (2005), Chiang et al.
(2013) considered a generic model to provide insights into the dynamic interaction between the service guarantee and
optimal payout levels; however, the factor of demand information updating was not considered. Zhang, Tan, and Dey
(2009) studied the competition between two Web service providers offering functionally the same Web services with a
game model. Each provider needs to decide a service level (standard or premium) she would offer and a corresponding
price for the selected service level to meet the guarantee which isn’t correlated with demand information updating. The
Equilibrium strategies are given. The most related modelling work is Liu and Xie (2013). They discussed the quality
decision of LSSC with service quality guarantee. The optimal quality decisions model of the LSI and FLSP are pre-
sented under three typical game modes: Nash game, Stackelberg game and centralised decision. Similarly, with the pre-
vious models, Liu and Xie (2013) didn’t consider the effect of demand information updating. Overall, these literatures
mentioned above don’t consider the effect of demand information update on the behaviour of service quality guarantee.
However, some scholars believed that the demand updating possibly affects the service quality by adjusting service
quality level (Yan, Liu, and Hsu 2003), changing service quality guarantee(Huang, Sethi, and Yan 2005) and improving
quality forecast (Yan and Wang, 2014), therefore, the relationship of demand updating and quality guarantee would be
concerned in our model building.

2.3 Service capacity purchasing of LSSC

As for the service capacity purchasing of LSSC, the current studies focus primarily on the capacity purchasing of LSSC
under random demand environment, while not in demand updating and quality guarantee environment. For example,
Liu (2008) considered a two-echelon supply chain structure consisting of a FLSP and a LSI in a single period, con-
structed LSI’s cost model and provider’s profit model under the uncertain environment, and established capacity coordi-
nation model based on the Stackelberg game. An options contract on logistics capability under Stackelberg game was
developed to increase the total profit in LSSC (Cui, Liu, and Zhang 2008). Liu et al. (2012) discussed the capacity coor-
dination in LSSC with options contract under Stackelberg game model. Associated with the service capacity purchasing
of LSSC mostly, the service order allocation of LSSC gradually attracts many researchers’ interests. In recent years,
some interesting behaviours are introduced into the order allocation models of LSSC. The typical behaviours include the
inequity aversion behaviour (Cheng, Tan, and Lin 2013), cumulative prospect theory (Liu, Liu, and Ge 2013), pre-esti-
mate behaviour, competitive-bidding behaviour (Liu et al. 2014), etc. In sum, these researches do neither pay attention
to the updating demand nor the service quality guarantee behaviour.
As shown above, researches about supply chain decisions with demand updating and service quality guarantee in a
LSSC have attracted much attention respectively, but the cross-research has not been reported. Obviously, demand infor-
mation updating influences decisions of supply chain members (Zhou and Wang 2012), while quality guarantee is
expected to stabilise participants’ decision behaviour in supply chain (Berman and Mathur 2014). Thus, it is worthwhile
to explore supply chain members’ decision behaviour with the interaction of these two factors, which possibly benefits
supply chain coordination. This article aims at the two-period decision-making process in a LSSC with demand updating
and quality guarantee. Based on the study of Liu and Xie (2013), supposing that the market demand is a quality guaran-
tee-sensitive stochastic variable and demand information will be updated after the first-period demand is realised, the
objective of this paper is to explore the optimal strategies of procurement quantity for service capacity and service qual-
ity defect rate guarantee before and after updating. Both cases are addressed with NGCC and GCC. By contrasting the
strategies of the LSI and the FLSP in four situations: (1) UCR and GCC; (2) UIR and GCC; (3) UCR and NGCC; and
(4) UIR and NGCC, we observe that the LSI may increase or reduce procurement quantity while the FLSP tends to
promise a higher quality defect rate in the second period. However, when the cost that the FLSP provides an additional
logistics capacity and the coefficient of GCC are great enough, it’s beneficial for both the LSI and the FLSP in the
second period to implement the initial strategies of the first period.

3. Models building and analysis

3.1 Problem descriptions
Consider a quality guarantee-sensitive LSSC composed of LSI I and FLSP F. I forecasts demand and requires F to
make a commitment on service quality defect rate, and then accordingly procures logistics service capacity from F.
Assume that one business calls for one service capacity. Besides, I will not alter the service quality guarantee level of F,
that is, the final quality level received by customers depends on the actual logistic service quality of F. We propose a
two-period decision process. In each period, I is faced with a random distribution of logistics service demand. After the
492 W. Liu et al.

demand in the first period is realised, I updates the distribution information of demand by contrasting the initial order
quantity and actual sales, then I shares the updated demand with F. Then I and F make adjustments of strategies in the
second period based on the updated demand forecasting result. To begin with, we propose two basic models of two
periods with NGCC and then the other two with GCC.
A multiplicative function is employed to indicate the relationship between customer demand di and quality defect
rate guarantee qi by F (Petruzzi and Dada 1999), i.e. di ¼ lðqi Þei , where i ¼ 1; 2, representing the number of periods;
lðqi Þ represents the deterministic part, which is a function of qi in period i. A lower qi corresponds to a larger lðqi Þ.
Hence, the demand is defined as lðqi Þ ¼ ebqi A (Hays and Hill 2001; Liu and Xie 2013); A is the potential market
demand, b is quality elasticity coefficient of demand. ei is the uncertain part of customer demand, which is a random
variable with a probability density function f and distribution function F. F is differentiable and strictly increasing and
Fð0Þ ¼ 0. Generally speaking, the customer is sensitive to both service quality and cost, but investigating pricing deci-
sions is not our research focus in this problem. Hence, we suppose that the customers are in a competitive marketplace,
thus p is exogenous. Obviously, when qi is given, the capacity quantity Qi procured by I only depends on ei . A conve-
nient expression is obtained by substituting zi ¼ Qi =lðqi Þ (zi is called procurement factor). If the choice of zi is larger
than the realised value of ei , then surpluses occur; if the choice of zi is smaller than the realised value of ei , then short-
ages occur (Petruzzi and Dada 1999). Therefore, zi is considered as the decision variable for LSI I.
The process how the LSI updates the demand is described as follows (Sarvary and Padmanabhan 2001; Glenn
2004): After the demand of the first period is realised, and in case that the capacity actually procured is larger than the
realised demand and the market uncertainty (denoted by e1 ) is completely revealed, the LSI decides the procurement
factor of the second period z2 ¼ e1 and the quantity of procured capacity Q2 ¼ lðq2 Þz2 ; in case that the capacity actually
procured is smaller than the realised demand and the market uncertainty is partly revealed, then the LSI updates market
f ðxÞ
demand distribution with Bayes laws, that is, the probability density function is gðxÞ ¼ 1Fðz 1Þ
and the distribution
FðxÞFðz1 Þ
function is GðxÞ ¼ 1Fðz1 Þ .
Since the actual service quality defect rate of the FLSP always has randomness when serving customers (Liu and
Xie 2013), the LSI tends to supervise and opts to penalise the FLSP according to the difference of the actual quality
defect rate and the guaranteed one. The penal rules are presented as follows: when the actual quality defect rate of the
FLSP (denoted by y) is lower than the guaranteed one qi , LSI I implements neither awards nor punishment; when y is
larger than the quality defect guarantee, LSI I punishes F and compensates for the quality defect as long as I realises
the situation. However, if I does not realise it and directly delivers the defective logistics service to the customer, I will
be punished by the customer.
Figure 1 shows the sequence of events: at the beginning of the first period, LSI I forecasts the current market
demand distribution on the basis of history data, and shares with FLSP F. Then I and F select the optimal service qual-
ity guarantee defect rate (denoted by q1 ) and procurement quantity of logistics service capacity (denoted by Q1 ) to max-
imise their own profits. At the end of the first period, the stochastic demand is realised, LSI I and FLSP F achieve their
own profits. At the beginning of the second period, I updates the demand distribution by contrasting the procurement
quantity and sales in the second period and shares it with F. And then, I selects the procurement quantity of service
capacity (denoted by Q2 ) and F guarantees the service quality defect rate (denoted by q2 ) to maximise their own profits
in the second period. At the end of the second period, when the stochastic demand is realised, I and F earn their profits.
In Figure 1, there are two synchronous event sequences: one (above the time axis) describes demand-updating process
and the other (under the time axis) illustrates quality guarantee process.

Figure 1. The sequence of events with demand updating.

 International Journal of Production Research 493

3.2 Assumptions

Assumption 1 The actual service quality defect rate y obeys the exponential distribution whose mean value is l (Hays
and Hill 2001; Liu and Xie 2013), and its probability density function and distribution function are separately repre-
sented as u and U. When the actual quality defect rate is larger than the guaranteed one (its probability is U ¼ 1  U),

where k1 is the penalty cost per business.
the expected penalty that will be paid to the customer per business is k1 U,

Assumption 2 The update demand information of the second period is obtained after the actual demand of the first
period is realised. The unmet demand cannot be left to the next period.

Assumption 3 After updating the demand information, if LSI procures more logistics service capacity from FLSP, which
inevitably upsets the original service capacity supply plan of FLSP, extra expenses for FLSP occur. However, if the LSI
decreases the procured quantity of logistics service capacity from FLSP, no extra expenses would occur due to the fact
that FLSP always cooperates with multiple LSI (Liu et al. 2011) and, thus, can find another LSI timely.

Assumption 4 w  cF \m\w and sk1 [ w  cF , where w; v; cF ; s, respectively, represent unit price in which FLSP
provides logistics service to LSI, reverse price of surplus capacity, FLSP’s operation cost per business and observed
coefficient of logistics service quality defects. Hence, sk1 is the expected penalty on the FLSP for quality defect. And
there is a limitation for the value of v (i.e. w  cF \m\w), which means that the LSI could not earn profit though
returning extra service capacity (as m\w) and shares the FLSP’s loss to stimulate the FLSP offering service capability
without reservation (as w  cF \m). sk1 [ w  cF ensures that the expected penalty on the FLSP is greater than its net
income, preventing it from deliberately offering service with quality defects.

Notations involved in this model are listed in Table 1.

Table 1. Notations for the model.

Symbol Description

qi Decision variable of F, quality defect rate guarantee in the ith period

Qi Procurement quantity of logistics service capacity in the ith period
zi Decision variable of I, purchasing factor in the ith period, zi  Qi =lðqi Þ
A The potential market demand
b Elasticity of customer demand to the quality defect guarantee
ei Random variable, the probability density is f and distribution function is F before the update; while the probability density
and distribution function after update are g and G, respectively
di Demand function in ith period, di ¼ lðqi Þei , where lðqi Þ ¼ ebqi A
y Actual service quality defect of F. y is a random variable with the exponential distribution U and probability density u, the
mean is Q1
p The unit price in which LSI provides logistics service to customers
cI Quality supervision cost of LSI per business
w The unit price in which FLSP provides logistics service to LSI
cF FLSP’s operation cost per business
v The reverse price of surplus capacity, where m\w þ cI
k1 Penalty value for per unit business that LSI imposes on FLSP
k2 Penalty value for per unit business that LSI pays to the customer
s Observed coefficient of logistics service quality defects
S Actual sales of logistics service capacity in the first period
T Expected inventory of logistics service capacity in the first period
SG The actual sales of logistics service capacity with UIR in the second period
TG Expected inventory of logistics service capacity with UIR in the second period
k Additional costs when FLSP supplies an extra unit service capacity
c The coefficient of GCC
Pji Expected revenue function of j for period i, where j equals fI; Fg and j represents LSI or FLSP

Notes: ‘*’ and ‘**’ represent the optimal solutions of NGCC and GCC, respectively. ‘  ’ and ‘^’ represent the cases of UCR and
UIR, respectively. In addition, for all the notations with subscript i, i ¼ 1; 2.
494 W. Liu et al.

3.3 The model in the first period

First of all, profit functions of the LSSC members in the first period are built.
As for LSSI I, before the customer demand of the first period is realised, I procures the certain quantity of service
capacity from F based on probability distribution of customer demand (denoted by Q1 ). The procurement price is w.
When the demand is realised, RQ the actual logistics service capacity used byR I in the first period is
Q
S ¼ E min½lðq1 Þe; Q1  ¼ Q1  0 1 F½x=lðq1 Þdx, and the surplus service capacity is T ¼ 0 1 F½x=lðq1 Þdx. If the surplus
service capacity occurs, I will return these surplus capacities and obtain corresponding income. The unit price of
returned surplus capacity is denoted by m, and w  cF \m\w which is limited by Assumption 4.
To meet service quality requirement of the customer, I is supposed to supervise F. If F breaks its commitment to
service quality (i.e. y [ q1 ) and I is informed of the situation, I will penalise F and has to compensate for the defects.
Suppose that the penalty value for per unit business on F is k1 and compensation cost for per unit business is b. While
if I does not realise F’s default and directly delivers the defective logistics service to the customer, I will be punished
by the customer. Suppose penalty cost per unit business paid to the customer is k2 . As logistics services are invisible
(Nie and Kellogg 1999), the probability that I realises F’s default is s (Liu et al. 2012), which is related to the difficulty
observing service procedure.
Then, the expected profits of I is:
pI1 ¼ pS þ sk1 Uðq1 ÞS  sbUðq1 ÞS  ð1  sÞk2 Uðq1 ÞS þ vT  Q1 ðw þ cI Þ
 Z Q1  Z
  Q1
¼ p þ sðk1  bÞUðq1 Þ  ð1  sÞk2 Uðq1 Þ Q1  F½x=lðq1 Þdx þ v F½x=lðq1 Þdx  Q1 ðw þ cI Þ (1)
0 0

In Equation (1), pS represents the income of I providing logistic service to the customer; sk1 Uðq1 ÞS and sbUðq1 ÞS
represent penalty income and compensation cost, respectively, when I realises that the actual quality defect rate is larger
than the guaranteed quality defect rate; ð1  sÞk2 Uðq1 ÞS represents the penalty cost of the customer on I if I does not
realise the quality defect and directly delivers the logistics service to the customer; vT is the return income of the surplus
logistics service capacity; Q1(w + cI) is the procurement and supervising costs.
As for FLSP F, apart from the income gained by offering service capacity to LSI I, its total profits in the first period
(denoted by pF1 ) contains two other parts: one is the cost that F pays for the returned surplus service capacity from I;
another is the penalty cost when the actual quality defect rate is larger than its guaranteed quality defect rate. Hence, the
expected profit pF1 of FLSP F is:
Z Q1  Z Q1 
p1 ¼ Q1 ðw  cF Þ  vT  sk1 Uðq1 ÞS ¼ Q1 ðw  cF Þ  v
F
F½x=lðq1 Þdx  sk1 Uðq1 Þ Q1  F½x=lðq1 Þdx (2)
0 0

In Equation (2), Q1(w − cF) represents the net service revenue of F, which equals the value that the procurement price
minus the service operation cost; vT is the cost for the returned surplus logistics service capacity; sk1 Uðq1 ÞS is the
penalty of I on F when the actual quality defect of F is larger than the quality defect guarantee.
Substituting procurement factor z1  Q1 =lðq1 Þ into Equations (1) and (2), profit functions of I and F can be rewritten
as follows:
8 I    R z1 
< p1 ¼ p þ sðk1  bÞUðq1 ÞR ð1  sÞk2 Uðq1 Þ lðq1 Þ z1  0 FðxÞdx
z1
þvlðq1 Þ 0 FðxÞdx  z1 lðq1 Þðw þ cI Þ (3)
: F Rz  Rz 
p1 ¼ z1 lðq1 Þðw  cF Þ  v 0 1 FðxÞdx  sk1 Uðq1 Þlðq1 Þ z1  0 1 FðxÞdx
Define kτ = τ(k1 − b) − (1 − τ)k2(ks  0), whose economic implication is to ensure that the LSI has a profit motive
to implement quality supervision on FLSP. Take the first-order derivatives of pI1 and pF1 on z1 and q1 , respectively, and
set them equal to 0, thus
8 @pI  
>
< @z1 ¼
> p þ ks Uðq1 Þ lðq1 Þ½1  Fðz1 Þ þ vlðq1 ÞFðz1 Þ  lðq1 Þðw þ cI Þ ¼ 0
1

@pF1  Rz  Rz 
¼ @lðq1Þ
z1 ðw  cF Þ  v 0 1 FðxÞdx  sk1 Uðq1 Þ z1  0 1 FðxÞdx (4)
>
>
@q @q
@Uðq1 Þ  R z1 
1 1
:
sk1 lðq1 Þ @q1 z1  0 FðxÞdx ¼ 0
In order to prove that Equation (4) is the optimal solution of LSI and FLSP, take the second-order derivatives of pI1
and pF1 on z1 and q1 , respectively:
 International Journal of Production Research 495

8 2 I  
< @ p21 ¼  p þ ks Uðq1 Þ lðq1 Þf ðz1 Þ þ vlðq1 Þf ðz1 Þ
@z1
 R   R 
: @ p21 ¼ b2 ebq1 z1 ðw  cF Þ  v z1 FðxÞdx A  ðb þ 1Þ2 eðbþl1Þq Ask1 z1  z1 FðxÞdx
2 F

@q 1
0 l 0
@ 2 pI1 @ 2 pF1
It can be proved that @z21
and @q21
(see Appendix 1). Then the Nash equilibrium solutions ðQ1 ; q1 Þ are obtained by satis-
fying Equation (5).
8 q
> lb lbðw  cF  vÞ z
>  l1
R z11
<e ¼
>
ðlb þ 1Þsk1
vþ
ðlb þ 1Þsk1 z1  0 FðxÞdx
q1 (5)
>
> p þ ks e l  w  cI
>
: Fðz 
1 Þ ¼ q1
p þ ks e l  v
where kτ = τ(k1 + k2 − b) − k2. If the distribution function can be precisely predicted, the specific q1 and z1 can be
calculated by Equation (5). Then the optimal order as well as the expected profits of the LSI and the FLSP or the whole
supply chain can be figured out. Equation (5) indicates that the optimal strategies of the LSI and the FLSP are not only
related to the parameters of cost and income, but also interrelated with the service procedure observability. Given the
procurement strategy of I (i.e. a given z1 ), a lower service procedure observability (i.e. a smaller s) motivates the pro-
vider to guarantee a lower service quality defect rate for the sake of more business. Besides, a serious information asym-
metry of the cooperation induces the LSI to procure excess service capacity with a given quality defect rate guarantee
(i.e. a given q1 ). Both situations lead to an increasing penalty cost from the customer, and the performance efficiency of
the supply chain will decrease.

3.4 Impacts of the demand information updating

Without demand information update, the LSSC system follows the procurement plan of service capacity and service
quality defect rate guarantee of the first period. However, when the information is updated, the distribution function of
random factor e will change from F to G. In addition, an extra cost will occur as the supply plan of the original
capacity of FLSP is disrupted.
Firstly, we define the procurement quantity Q2 of the LSI when the uncertainty of demand information is completely
and incompletely revealed as Equation (6):
(
e 2;
Q S\Q1
Q2 ¼ (6)
b 2;
Q S ¼ Q1
where Qe 2 ¼ lðq2 Þ Q and Q
b 2 are the capacity quantities procured by the LSI in the second period in the case of UIR.
lðq1 Þ 1
The management insights of Equation (6) are that when the sales volume of service capacity is less than its procurement
volume in the first period, the procurement volume is Q e 2 for the LSI in the second period; when the sales volume is
equal to the procurement volume in the first period, the procurement volume forRthe LSI is Q b 2 in the second period.
þ1
Then the expected sales volume of logistics service capacity is ShG ¼ lðq2 Þ z minðz2 ; xÞgðxÞdx,
i and the expected
R þ1 1
surplus service capacity at the end of the second period is TG ¼ lðq2 Þ z2  z minðz2 ; xÞgðxÞdx . Hence, the expected
1

profit of LSI in the second period (denoted by pI2 ) is obtained:

Z z1
    
pI2 ¼ ½1  Fðz1 Þ p þ ks Uðb
q 2 Þ SG þ vTG  z2 lðq2 Þðw þ cI Þ  p þ ks Uðe
q 2 Þ  w  cI lðe
q2Þ xf ðxÞdx (7)
0

where e q 2 and b
q 2 represent the service quality defect rate guarantees by the FLSP separately in the case of UCR and
UIR.
As for FLSP, if the LSI procures more logistics service capacity according to the updated demand information, the
original service capacity supply plan of the FLSP will be disrupted and need to be adjusted, causing some extra capacity
cost (apart from the operation cost). Suppose that extra cost per unit service capacity is k, and then, we easily obtain
the total extra cost of FLSP kðQ2  Q1 Þþ ¼ kAðbz 2 ebbq 2  z1 ebq1 Þþ. Based on assumption 4, when the LSI reduces its


procurement capacity, no capacity idle cost for the FLSP will occur. Therefore, the expected profit of FLSP F in the
second period (denoted by pF2 ) is obtained:
496 W. Liu et al.

n o
q 2 ÞSG  kAðbz 2 ebbq 2  z1 ebq1 Þþ

pF2 ¼ ½1  Fðz1 Þ bz 2 lðb
q 2 Þðw  cF Þ  vTG  sk1 Uðb
Z z (8)
  1
w  cF  sk1 Uðe q 2 Þ lðe
q2Þ xf ðxÞdx
0

where xþ = maxð0; xÞ. For convenience, e p F2 and pb F2 are defined to indicate the profits of FLSP F in the case of UCR
and UIR, satisfying Equation (9):
8   R z
<ep F2 ¼ w  cF  sk1 Uðe q 2 Þ lðe
q 2 Þ 0 1 xf ðxÞdx
 þ (9)
:b q 2 ÞSG  kA bz 2 ebbq 2  z1 ebq1

p F2 ¼ bz 2 lðb
q 2 Þðw  cF Þ  vTG  sk1 Uðb

3.5 The models in the second period

The following part discusses the optimal strategies of LSI I and FLSP F in the second period, which is divided into four
scenarios: (1) UCR and GCC; (2) UIR and GCC; (3) UCR and NGCC; and (4) UIR and NGCC.

3.5.1 UCR and NGCC

As mentioned above, in the case of UCR and NGCC, the optimal decision for LSI I is ez 2 ¼ e1 and then Q2 ¼ eq2 Ae1 .
In this situation, to obtain the optimal decision of FLSP F, we take the first-order derivative of e p F2 about e
q 2 and set it
as 0:

 Z z Z z
@pF2 eq 2 sk1 eql2 beq 2
¼ b w  cF  sk1 e l ebeq 2 A
1 1
xf ðxÞdx þ e e A xf ðxÞdx ¼ 0
@e
q2 0 l 0

And then e
q 2 must satisfy Equation (10):
eq 2 lbðw  cF Þ
e l ¼ (10)
sk1 ðlb þ 1Þ
Thus, under the condition of UCR and NGCC, the optimal quality defect rate guarantee for FLSP F is
sk1 ðlb þ 1Þ
q 2 ¼ l ln
e (11)
lbðw  cF Þ
Since R z1 z1 [ 1, When comparing Equations (5) and (11), the inequality is gotten
FðxÞdx
0
lb lbðw  cF  vÞ z1 lbðw  cF Þ
vþ R [
ðlb þ 1Þsk1 ðlb þ 1Þsk1 0z1 FðxÞdx ðlb þ 1Þsk1
In the inequality, the left side is equal to eq1 =l and the right side is equal to eeq 2 =l , so q1 \e
 
q 2 . Since the capacity
e  beq 2 
procurement quantity R 
of LSI in the second is Q 2 ¼ ez 2 e while the one in the first period is Q1 ¼ z1 ebq1 , note that
q1 \e e 2 . Theorem 1 can be obtained.
q 2 and ez 2 ¼ 0 1 xf ðxÞdx\z1 , therefore, Q1 [ Q
z

Theorem 1 Compared with the first period, in the case of UCR and NGCC, FLSP in the second period will increase
q 2 [ q1 . Meanwhile, LSI will decrease its procurement logistics service capac-
its guaranteed quality defect rate, that is, e
e
ity, that is, Q 2 \Q1 .

Theorem 1 indicates that with UCR and NGCC, the second period will obtain some informational advantages com-
pared with the first period. FLSP will decrease quality guarantee standard and the LSI will reduce procurement quantity.
As a result, the extra penalty cost of a low committed quality defect rate and excess procurement of service capacity
can be cut down.
 International Journal of Production Research 497

3.5.2 UIR and NGCC

As to the case of UIR and NGCC, the density function f and distribution function F are claimed to be changed into g
and G. For LSI, to optimise the procurement quantity of service capacity, we take the first-order derivative of its profit
@b
pI
function b
p I2 on bz 2 and set it to 0, namely @z22 ¼ 0, thus
@pI2     
¼ 1  Fðz1 Þ lðb
q 2 Þ p þ ks Uðb
q 2 Þ ½1  Gðbz 2 Þ þ vGðbz 2 Þ  ðw þ cI Þ ¼ 0
@bz 2
q 2 , bz 2 can be calculated by Equation (12):
Given the service quality defect rate guarantee b
bq 2
p þ ks e l  w  cI w þ cI  v
Fðbz 2 Þ ¼ þ Fðz1 Þ (12)
b
q2 b
q2
p þ ks e l  v p þ ks e l  v
According to Equation (12), Theorem 2 can be obtained.

Theorem 2 In case of UIR and NGCC, bz 2  z1 and Q2 [ Q1 hold for any given quality defect rate guarantee q2 .
Proofs According to Equation (12), we can get

p þ ks ebq 2 =l  w  cI w þ cI  v p þ ks ebq 2 =l  w  cI
Fðbz 2 Þ  Fðz1 Þ ¼ þ Fðz1 Þ  Fðz1 Þ ¼ ½1  Fðz1 Þ [ 0
p þ ks ebq 2 =l  v p þ ks ebq 2 =l  v p þ ks ebq 2 =l  v
Hence, Fðbz 2 Þ [ Fðz1 Þ holds. Since FðxÞ is a strictly increasing function of x, bz 2 [ z1 . In addition, as Qi ¼ zi ebqi A
holds, it is easy to prove Q2 [ Q1 for any given q.
Theorem 2 indicates that with UIR and NGCC, if FLSP doesn`t alter its quality defect rate guarantee (i.e. q1 ¼ q2 ),
LSI will procure more logistics service capacity to meet the potential demand of its customer. Notice that the customer
is to some extent unwilling to accept a worse quality guarantee defect rate. This characteristic does make a difference
when FLSP guarantees a higher quality defect rate, which was discussed concretely in Section 4.
Moreover, in the case of UIR and NGCC, if LSI increases its capacity procurement quantity, namely Q2 [ Q1 or
q 2 Þ [ z1 lðq1 Þ, the expected profit of FLSP is
bz 2 lðb
n o
q 2 ÞSG  kAðz2 ebbq 2  z1 ebq1 Þ

pF2 ¼ ½1  Fðz1 Þ z2 lðb
q 2 Þðw  cF Þ  vTG  sk1 Uðb
Z z
  1
þ w  cF  sk1 Uðe q 2 Þ lðe
q2Þ xf ðxÞdx
0
@pF
Given a specific bz 2 , make the first-order derivative of pF2 on b
q 2 and set 2 ¼ 0. Thus, the optimal quality guarantee
 @b
q2
defect rate b
q 2 for FLSP satisfies
vlb lbðw  cF  v  kÞbz 2
ebq 2 =l ¼

þ  
ðlb þ 1Þsk1 R bz Rz
ðlb þ 1Þsk1 bz 2  0 2 GðxÞdx þ 0 1 GðxÞdx
FðxÞFðz Þ
where GðxÞ ¼ 1Fðz Þ1 . Given k and other parameters, we can obtain the optimal strategies of LSI and FLSP with UIR
and NGCC (denoted by ðbz 2 ; b
q 2 Þ), satisfying Equation (13):
1

8 w þ cI  v
>
> Fðbz 2 Þ ¼ 1  ½1  Fðz1 Þ
>
> b
< p þ ks e  q 2 =l v
b
q 2 =l vlb lbðw  cF  v  kÞbz 2 (13)
>
> e ¼ þ 
>
> ðlb þ 1Þsk1 R bz FðxÞFðz Þ

: ðlb þ 1Þsk1 bz 2  z2 1Fðz Þ1 dx
1 1

According to Equation (13), when k increases, FLSP will increase its quality guarantee defect rate and LSI will
choose a smaller z2, which leads to the decrease of the capacity procurement quantity. Notice the fact that if the extra
capacity cost of increasing the procurement quantity is too much, the eventual outcome is that LSI procures the same
quantity of capacity as the previous period. Therefore, it can be presumed whether LSI increases the procurement capac-
ity is closely related with k. Hence, a further discussion of the critical condition for LSI is conducted to increase its
capacity procurement quantity.
498 W. Liu et al.

Let Hðb q 2 Þ ¼ b1 ln bzz2 þ q1  b

q 2 , where bz 2 can be obtained by Equation (13), hence, Q2 [ Q1 be equivalent to the
situation that there exists a feasible solution b
1
q 2 which makes Hðb q 2 Þ [ 0 hold.
As FðxÞ is a strictly increasing function of x, it can be proved that bz 2 is a decreasing function of b q 2 , and further-
more, Hðb q 2 Þ is the decreasing function of b q 2 . According to Equation (13), the quality guarantee defect rate b q 2 will
increase with the increase in k. Hence, Hðb q 2 jkÞ is the decreasing function of k. Theorem 3 can be obtained:
Theorem 3 In the case of UIR and NGCC, if Hðb
 q 2 jk ¼ 0Þ [ 0 holds, there is a critical value k0 that makes
Q2 [ Q1 ; if k\k0
q 2 jk ¼ 0Þ 0 holds, Q2 ¼ Q1 always holds for
q 2 jk ¼ k0 Þ ¼ 0; if Hðb
hold, where k0 satisfies Hðb
Q2 ¼ Q1 ; if k  k0
any given positive k.
Theorem 3 indicates that k does affect the final capacity procurement quantity of LSI. When k is too large, FLSP
prefers LSI keeping the same procurement quantity as the first period. Cost subsidies to FLSP are advised for rearrang-
ing service capacity supply plan if LSI wishes to meet more customer demand and lower the quality guarantee defect
rate, such as cost-sharing contracts.

If LSI doesn’t increase its capacity procurement quantity (Hðb q 2 jk ¼ 0Þ 0), the optimal strategies of FLSP and LSI
(denoted by ðbz non
2 ; b
q non
2 Þ) satisfy
8
> w þ cI  v
>
> Fðbz non Þ¼1 ½1  Fðz1 Þ
>
>
2
p þ ks ebq 2 =l  v
<
bq non vlb lbðw  cF  vÞbz 2 (14)
 2l
>
> e ¼ þ 
>
> ðlb þ 1Þsk1 R bz FðxÞFðz Þ

>
: ðlb þ 1Þsk1 bz 2  z2 1Fðz Þ1 dx
1 1

Given the distribution function FðxÞ and other parameters, the optimal capacity procurement quantity for LSI can be
b non ¼ bz non ebbq non
calculated as Q 2 A.
2 2

3.5.3 UCR and GCC

Customers are always sensitive to the service quality especially when a change takes place. Customers will be unsatis-
fied with a worse service quality guarantee, that is, when a higher quality defect rate is guaranteed. Apart from loss of
customer demand, the FLSP will suffer from the loss of goodwill. We quantify the loss and define it as GCC (denoted
by X). Notice that Sections 3.5.1 and 3.5.2 actually propose special situations where X ¼ 0. The following sections aim
for more general issues where the GCC is a linear function of the change extent of quality guarantee and work on the
strategies of LSI and FLSP. One of our main work is to figure out whether there is a critical condition that FLSP intends
to hold its promise in both periods. Let Dq ¼ q2  q1 , hence, X ¼ cDq, where c(c [ 0) is the coefficient of GCC. When
Dq [ 0 holds, there exists disutility of quality guarantee with an increased quality defect rate guarantee, that is, FLSP
suffers from the cost of worse guarantee; otherwise, there exists positive utility and FSLP gains benefits from a better
guarantee.
In the case of UCR and GCC, the expected profit of FLSP is
Z z
1
e
p 2 ¼ ½w  cF  sk1 Uðe
F
q 2 Þlðe
q2Þ xf ðxÞdx  cDq
0

Calculate the first-order derivative of e

on e
p F2
q 2 and set it to 0, thus we obtain the optimal quality guarantee defect
rate of FLSP eq 
2 , satisfying:
 Z z
sk1 eq  =l
e 2  bðw  cF  sk1 eeq 2 =l Þ ebeq 2 A
  1
xf ðxÞdx  c ¼ 0 (15)
l 0

q 
The solution process of e 2 is shown in Appendix 2.
The condition of FLSP not altering its quality guarantee is, p q 2 ¼ q1 Þ  e
e F2 ðe p F2 ðeq2 ¼ eq 
2 Þ  X, hence,
Z z
ðw  cF Þðebeq 2  ebq1 Þ þ sk1 ½eð1=lþbÞq1  eð1=lþbÞeq 2 
   
1
c   A xf ðxÞdx
ðe q 2  q1 Þ 0

Theorem 4 can be obtained based on the above equation.

 International Journal of Production Research 499

Theorem 4 In the case of UCR and GCC, there is a critical value of the coefficient of GCC c1 . We have e q2 ¼ eq 
2 if
be
q  bq ð1=lþbÞq ð1=lþbÞe
q  R 
q 2 ¼ q1 ifγ ≥ γ1, where c1 ¼ ðwcF Þðe
2 e 1 Þþsk1 ½e 1 e 2 
q 
z
γ < γ1 and e A 0 1 xf ðxÞdx and e 2 can be obtained
ðe
q 
2
q1 Þ
from Equation (15).
Theorem 4 gives the condition for FLSP not to alter its quality guarantee when guarantee cost is a linear function of
quality guarantee change and the demand uncertainty is revealed completely. When the opportunity cost of changing its
guarantee is too large, FLSP prefers to keep the initial guarantee; while when the opportunity cost is relatively low,
FLSP tends to lower its quality guarantee defect rate.

3.5.4 UIR and GCC

In the case of UIR and GCC, similarly, we can obtain the condition for LSI to increase its procurement quantity.

Theorem 5 In the case of UIR and GCC, there exists a critical value k1 if Hðb
 q 2 jk ¼ 0Þ [ 0 and we have
Q [ Q
; if k\k
2 1 1
q 2 jk ¼ k1 Þ ¼ 0; Q
, where k1 satisfies Hðb 
2 ¼ Q1 always holds if Hðb q 2 jk ¼ 0Þ 0 for any
Q 
2 ¼ Q1 ; if k [ k1
given k [ 0.

Theorem 5 is similar to Theorem 3 and reveals the critical conditions for LSI to increase its procurement quantity
with UIR and GCC. The following analysis is divided into two categories on the basis of the facts whether LSI
increases its procurement quantity or not.
Consider the situation that LSI increases its capacity procurement quantity, namely Hðb q 2 jk ¼ 0Þ [ 0 and k\k1 .
The expected profit of FLSP is

q 2 Þ  kAðbz 2 ebbq 2  z1 ebq1 Þ  cDq


b q 2 Þðw  cF Þ  vTG ðbz 2 ; b
p F2 ¼ bz 2 lðb q 2 ÞSG ðbz 2 ; b
q 2 Þ  sk1 Uðb
b F2 on b
Calculate the first-order derivative of p q 2 and set it to 0, hence, the optimal quality guarantee defect rate by FLSP

b
q 2 satisfies


1
ðk  w þ cF ÞbAbz 2 ebbq 2 þ bvTG ðb
q 2 ; bz 2 Þ þ þ b sk1 ebq 2 =l SG ðb
q 2 ; bz 2 Þ ¼ c (16)
l
w þ cI  v
where bz 
2 satisfies Fðb z 
2 Þ¼ 1 ½1  Fðz1 Þ. Therefore, the condition for FLSP not to alter its
b
q  =l
committed guarantee is p þ ks e 2  v

b q 
q2 ¼ b
p F2 ðb 2 ;b z 2 ¼ bz  q 
2 Þ  cðb

2  q1 Þ b q 2 ¼ q1 ; bz 2 ¼ z2 Þ
p F2 ðb (17)
 
wþcI v
where z2 ¼ F 1 1  
q =l ½1  Fðz 
1 Þ .
pþks e 1 v
Theorem 6 could be obtained.

Theorem 6 In the case of UIR and GCC, when Hðb q 2 jk ¼ 0Þ [ 0 and k\k1 , the coefficient of GCC has
a critical value c2 , which ensures the optimal
 strategies of FLSP and LSI satisfy
q 
ðb ; bz  Þ if c\c2 1 wþcI v 
ðbq 2 ; bz 2 Þ ¼ 2 2 , where z2 ¼ F 1 ½1  Fðz1 Þ and c2 satisfies
ðq1 ; z2 Þ if c  c2 q =l
pþks e 1 v
( )
bb
q  
ðbz 
2 e
2  z ebq1 ÞAðw  c Þ  v½T ðb 
G z2 ; bq  
2 Þ  TG ðz2 ; q1 Þ 
c2 ¼ 2 F
q 
=ðb 
2  q1 Þ.
b 
q 2 =l   
q1 =l   bb 
bq1
sk ½e
1 G 2 S ðbz ; b
2 q Þe G 2 S ðz ; q Þ  kAðbz e
1 2
q2
2 z e Þ
Theorem 6 gives the critical condition for FLSP not to change its quality guarantee when LSI increases its procure-
ment quantity with UIR and GCC. It is similar to Theorem 4.

Similarly, Theorem 7 can be obtained:

500 W. Liu et al.

Theorem 7 In the case of UIR and GCC, when Hðb q 2 jk ¼ 0Þ [ 0 and k  k1 or Hðb q 2 jk ¼ 0Þ\0, the coefficient of
GCC has a critical value c3 , which ensures the optimal strategies of FLSP and LSI satisfy
 non non
ðbz 2 ; b q 2 Þ if c\c3
ðb
q non ; b
z non
Þ ¼  , where ðbz non ;b
q non Þ satisfies
2 2
8 ðq 1 ; z2 Þ if c  c 3
2

2

< bbz 2 ebbq 2 Aðw  cF Þ þ bvTG ðb q 2 ; bz 2 Þ þ l1 þ b sk1 ebq 2 =l SG ðb
q 2 ; bz 2 Þ ¼ c
and
: Fðbz 2 Þ ¼ 1  wþcI v ½1  Fðz1 Þ
pþks ebq 2 =l v

( )
bb
q non bq1 
ðbz non e  z e ÞAðw  c Þ  v½T ðb
z non
; b
q non
Þ  T ðz ; q Þ
 q1 Þ
2
c3 ¼ 2 2 F G 2 2 G 2 1 =ðb
q non
bq non =l q1 =l  2
sk1 ½e 2 sG ðbz 2 ; b
non
q2 Þ  e
non
SG ðz2 ; q1 Þ

Theorem 7 gives the critical condition for FLSP not to change its quality guarantee when LSI increases capacity pro-
curement quantity in the case of UIR and GCC. It is also proved that FLSP prefers to keep the initial guarantee if the
opportunity cost of changing guarantee is too large, while when the opportunity cost is lower, FLSP selects its quality
guarantee defect rate based on maximising its profit.

4. Discussion
Based on Theorem 1–7, we contrast the procurement quantities of service capacity and quality guarantee defect rates in
four scenarios, as shown in Table 2.
Table 2 contrasts the strategies of the LSI and the FLSP in two periods with the combination of four scenarios.
Firstly, compared with the first period, the LSI is supposed to purchase more service capacity and the FLSP tends to
guarantee a higher quality defect rate in the second period in the case of UCR and NGCC. Secondly, in the case of
UIR and NGCC, whether the LSI and the FLSP adjust their strategies depends on the extra capacity cost. Thirdly, in
the case of UCR and GCC, the LSI is supposed to purchase more service capacity while whether the FLSP altering its
guarantee depends on the cost of changing its guarantee. Finally, in the case of UIR and GCC, whether the LSI and the
FLSP altering their strategies is related with both the coefficient of GCC and the extra capacity cost; when both of them
are great enough, it is beneficial for both the LSI and the FLSP in the second period to implement the initial strategies.

5. Numerical analysis
Numerical simulation is conducted in this section to verify the conclusions made above. We focus on the influences of
the parameters k, X and γ on the quality guarantee defect rate of the FLSP and the procurement quantity of the LSI.
With a PC with 1.6 GHz quad-core processor, 4G Byte memory and windows 8 system, we programmed and simulated
numerical results using Matlab 8.0. To simplify the numerical analysis, we assume that random factor e obeys a uniform
distribution with the range of ½0; 1, namely, f ðxÞ ¼ 1 and FðxÞ ¼ x. The values of other parameters are as follows:
p ¼ 99, w ¼ 45, v ¼ 22, cF ¼ 18, cI ¼ 8, k1 ¼ 16, s ¼ 0:8, k2 ¼ 40, l ¼ 0:05, b ¼ 2, b ¼ 3, A ¼ 100. The numerical
analysis mainly focuses on the following:

Table 2. Contrasts of the strategies in four scenarios before and after demand updating.

Item NGCC GCC


e
q 2 > q1 ; Q
UCR e 9c1 s.t. e
q2 ¼ q 
e e2
2  2 ; c:; Q

Q2 [ Q1 ; if k\k0 q 
b 2 ; c\c2 ; Q > Q
UIR 9k0 ; s.t. then (1) When c where Hðc ¼ c1 > 0Þ ¼ 0, 9c2 s.t. b
q2 ¼
Q2 ¼ Q1 ; if k  k0 q1 ; c  c2 2 1
b
q2 ¼ b q 2
(2) When k  k1 where Hðk ¼ k1 > 0Þ ¼ 0 or when Hð^
q2 jk ¼ 0Þ,
q 
b 2 ; c\c3 ;
9c3 s.t. b
q2 ¼ Q
2 ¼ Q1

q1 ; c  c3

Notes: Subscript 1 presents the first period (before demand updating); subscript 2 presents the second period (after demand updating).
γ3 is the guarantee cost coefficient γ.
 International Journal of Production Research 501

(1) In the premise of NGCC, we will explore the optimal capacity purchase quantity of the LSI and the
optimal quality guarantee defect rate of the FLSP under UCR before and after demand updating, and
figure out the correlation of b b 2 , and k influenced by demand information updating under UIR.
q2, Q
(2) In the premise of guarantee change cost (GCC), based on the assumption that guarantee change cost
should be related to quality guarantee defect rate, we will discuss the correlation of b b 2 and k under
q2, Q
UCR and UIR, respectively.

5.1 UCR and NGCC

Based on Equation (7), the optimal quality defect rate committed by the FLSP and the optimal capacity quantity pro-
cured by the LSI in the first period are q1 ¼ 0:0788 and Q1 ¼ 51:3, and correspondingly the profits of the LSI and the
FLSP are pI1 ¼ 1191:6 and pF1 ¼ 950:5. After the demand information is updated in the second period, in the case of
UCR and NGCC, the optimal quality guarantee defect rate of the FLSP is e q 2 ¼ 0:0826 (larger than q1 ) and the optimal
capacity quantity procured by the LSI is 50.9 (smaller than Q1 ), that is, the quality guarantee defect rate is increased
while the capacity procurement quantity is decreased, as Theorem 1 predicts.

q 2 with k (UIR and NGCC).

Figure 2. Variation tendency of b

b  with k (UIR and NGCC).

Figure 3. Variation tendency of Q 2
502 W. Liu et al.

q 2 with c (UCR and GCC).

Figure 4. Variation tendency of e

5.2 UIR and NGCC

Figures 2 and 3 show the relationship of the quality guarantee defect rate b q 2 and the capacity procurement quantity Q b2
with k in the case of UIR and NGCC. Figure 2 indicates that the FLSP will improve its guaranteed quality defect rate
in the second period (compared with the first period) for any given k. b q 2 increases rapidly as k increases and b
q 2 reaches
its maximum and keeps constant when k [ 24:2. Figure 3 shows that Q b  decreases as k increases, and Q b  ¼ 51:3 when
2 2
k [ 24:2. In other words, there is a critical value k ¼ 24:2 as predicted by Theorem 3. Figures 2 and 3 also suggest that
as the extra capacity cost of the FLSP increases, the FLSP will lower its quality standard and the LSI will reduce its
procurement quantity. When k is higher than a critical value (k [ 24:2), the FLSP will guarantee a relatively high
quality defect rate to impel the LSI to procure the initial quantity of service capacity.

5.3 UCR and GCC

Figure 4 shows the variation tendency of quality guarantee defect rate of FLSP e q 2 with guarantee change cost coeffi-

cient c in the case of NCR and GCC. The quality guarantee defect rate of FLSP e q 2 decreases as c increases. In addition,
there is a critical value c1 ¼ 65:9, and where if c [ c1 , the optimal strategy for the FLSP is to keep the initial quality
guarantee.

5.4 UIR and GCC

b  with c in the
q 2 and capacity procurement quantity Q
Figures 5 and 6 show variation tendencies of quality defect rate b 2

case of UIR and GCC. Given k(k ¼ 10; 20 and 30), b q 2 decreases as c increases. There is a critical value c2
(c2 ¼ 1053:5, 2523.6 and 3993.8, correspondingly), and where if c [ c2 , the optimal strategy for the FLSP is to keep
the initial quality guarantee, as predicted by Theorem 6. Notice that when k ¼ 30 and 0\c\595:06, the FLSP selects
a relatively high guarantee quality defect rate to impel the LSI to procure the initial quantity of service capacity

q 2 with c (UIR and GCC).

Figure 5. Variation tendency of b
 International Journal of Production Research 503

b  with c (UIR and GCC).

Figure 6. Variation tendency of Q 2

(as mentioned above), reducing the extra capacity cost. With the increase of GCC, the FLSP will make a balance
between these two costs caused by changing guarantee and supplying more capacity and thereby decrease the quality
guarantee standard.

6. Main conclusions and management insights

6.1 Main conclusions
From Table 2 and the numerical analysis in Section 5, the optimal cooperation strategies of LSI and FLSP in four
scenarios are concluded as follows:
(1) In the case of NGCC and UCR, comparing to the cooperation strategy of the first period, the optimal
cooperation strategy for the two parties after demand information update is that the FLSP adopts a higher
quality guarantee defect rate and the LSI reduces its capacity purchase quantity.
(2) In the case of NGCC and UIR, k influences the optimal cooperation strategy for the two parties and theirs,
and it has a critical value. If k is lower than the critical value, when k increases, the quality guarantee
defect rate of the FLSP increases while the capacity purchase quantity decreases, and the optimal coopera-
tion strategy is ascertained by resolving and utilising the equilibrium k. If k is larger than the critical
value, the quality guarantee defect rate of the FLSP and the capacity purchase quantity of the LSI are
constant, thus, the optimal cooperation strategy is ascertained when k equals to its critical value.
(3) In the case of UCR and GCC, the optimal cooperation strategy is that the LSI will reduce its procurement
quantity of service capacity. But whether the FLSP changes its quality defect rate guarantee depends on
the value of the coefficient c. When c is higher than a specific value, the FLSP prefers to keeping its
initial guarantee, otherwise, the FLSP will lower its quality defect rate guarantee.
(4) In the case of UIR and GCC, the optimal cooperation strategy of the FLSP and the LSI depends very
closely on k and c. When k increases, the FLSP will decrease its quality guarantee level based on a trade-
off between cost of guarantee change and the cost of capacity providing increase, and the LSI would like
to decrease the capacity purchase quantity. Particularly, when both k and c are great enough, the optimal
strategies for the FLSP and the LSI are to perform the initial strategies of the first period.

6.2 Management insights

6.2.1 Insights for researchers
This paper explores the optimal strategies of the FLSP and the LSI in two-period cooperation with the quality defect
rate guaranteed. A contrast is conducted about the impact of the occurrence of GCC on the decision process. Numerical
analysis is carried out to verify and dig out some conclusions. Our contributions for researchers are mainly in the
following areas:
504 W. Liu et al.

(1) The problem on purchase decision and service quality guarantee with demand information update in a sup-
ply chain has already been studied, respectively, by many researchers, but the cross-research of these two
problems is relatively rare. The paper focuses on the cross-research and finds the impact of demand infor-
mation updating on quality guarantee behaviour though mathematical model which could offer a reference
for relative cross-research in the future.
(2) Unlike normal product demand, the service demand is more easily affected by service quality. In
researches on capacity procurement strategy of LSSC, few consider the impact of quality guarantee defect
rate on capacity procurement decision of the LSI. Thus, this paper introduces the quality guarantee behav-
iour into the decision model and presents customer demand in a function of the quality guarantee defect
rate offered by the FLSP, which extends the research of the capacity procurement decision of LSSC.
(3) Based on the work of Liu and Xie (2013), our study makes a further step to the optimal strategies in a
LSSC environment. An analysis is conducted to unearth the impact of the demand uncertainty revelation
and guarantee change cost on the quality guarantee behaviour, the procurement strategy and profits,
respectively. Hence, our work also provides a general track for the problems of uncertain market demand.

6.2.2 Insights for managers

Our research work provides some guidance for managers to understand the adopted strategies and manage the members
of a LSSC.
(1) For the entire LSSC, the greatest contribution of our work is solving the problem of how the LSI and the
FLSP make their optimal strategies under different situations (UCR/UIR, NGCC/GCC). In addition, we
explicitly point out the conditions when the LSI and the FLSP keep or alter their initial strategies of the
first period.
(2) In the sake of a better performance in the two-period (or multi-period) cooperation, the LSI could make
efforts in the following three aspects: firstly, the LSI should strengthen the management of current market
information updating and reduce the uncertainty of demand. Secondly, the LSI is also suggested to under-
take part of the extra service capacity cost, and thereby cushion the decrease of demand due to a
decreased quality guarantee level. Finally, if the LSI thinks highly of the unified guarantees in each period
(e.g. to build a service brand), it is helpful to increase the guarantee change cost or promise to reward the
FLSP if the FLSP keeps its quality defect rate guarantee.
(3) The FLSP is suggested to strive for an initiative role in the multi-period cooperation. For instance, the
FLSP should enhance information communication to respond to the LSI’s emergency procurement require-
ments quickly. Besides, supply flexibility of the logistics service capabilities should be strengthened to
reduce the extra capacity cost.

7. Model application: a case from Yuantong Express Company of China

In this section, the service capability procurement decision of Yuangtong Express Company of China under the demand
updating and quality guarantee would be discussed. The brief introduction of this company could be seen in Section 7.1,
and then the main problems in service capability procurement of Yuantong Express are given in Section 7.2. The new
solutions for service capability procurement based demand updating and quality guarantee will be proposed in
Section 7.3. At last, the effect of new solutions is provided in Section 7.4.

7.1 Brief introduction of Yuantong Express Company of China

In terms of scale, Yuantong Express Company of China is one of the largest express companies in China. With its head-
quarter located in Shanghai, this company is in charge of 8 management districts, 69 transfer centres and over 6000 dis-
tribution centres nationwide, and has over 12,000 employees. Its direct service covers over 1900 cities and 70 transport
airports. Based on its main business of small package within 50KG express service, Yuantong Express has continuously
enlarged its business to offer a more diversified service catalogue to the customers such as ‘the Same City, delivered in
one day’, ‘the Same Province, delivered in one day’ and ‘Cross province, delivered in time’. Considering its representa-
tiveness, the paper chooses the case of Tianjin Yuantong Express to make a detailed analysis.
 International Journal of Production Research 505

7.2 Main problems in service capability procurement

Tianjin Yuantong Express is the middle-northern branch office of Yuantong Express of China, and accounts for 20% of
express market in Tianjin. Stimulated by the rapid development of E-commerce in China, the express package business
of Yuantong Express keeps an annual growth rate of over 50% in the past few years, and always usher its busiest day
around 11th, Nov, the day when E-commerce enterprises are on annual biggest sale. For example, on 11 November
2011, Tianjin Yuantong Express received 150,000 orders from E-commerce enterprises while the total receipt volume of
express packages nationwide is 2,670,000. Though these express packages were expected to deliver within 3–5 days,
Tianjin Yuantong Express suffered from lack of preparation of logistics service capacity and had problems (delayed
delivery and goods damage) in keeping its words, leading to customers’ dissatisfactory. How to deal with booming
demand and make right decision on service capability procurement have been put on the agenda of Tianjin Yuantong
Express.

7.3 New solutions for service capability procurement-based demand updating and quality guarantee
With lessons of 2011, in October 2012, Tianjin Yuantong Express made sufficient preparation one month before the
online shopping annual biggest sale. Having forecasted the demand of express packages service on the E-commerce
biggest sale day in 2012, Tianjin Yuantong Express negotiated with its FLSPs on a series of problems of service capac-
ity procurement and service quality guarantee in advance. The main contents of their agreements are as follows:
(1) In the mid-month of October 2012, before the service capability needed in the sale promotion season in
November is procured, Tianjin Yuantong Express negotiated with 42 FLSPs in Tianjin and requested their
service quality guarantee from 11 November 2012 to 20 November 2012, which was supported with cor-
responding awards and punishments based on FLSPs’ actual service quality. For example, once the service
quality provided by a FLSP is lower than its guaranteed quality, it would be punished according to the
seriousness of quality defect, and it would even be removed from Tianjin Yuantong Express’s supplier list
in the severest case.
(2) Tianjin Yuantong Express shared the forecast information of customer demand with its 42 FLSPs. In late
October 2012, it procured logistics service capacity from every FLSP in advance, leaving the FLSPs
enough time to prepare a reasonable level of service capacity according to the forward orders.
(3) At the beginning of November, many E-commerce enterprises started sales promotion. Based on renewed
demand information, Tianjin Yuantong Express adjusted its procurement volume of service capacity, and
correspondingly, FLSPs changed their service quality guarantee. Though the market demand was not com-
pletely revealed, Tianjin Yuantong Express increased its procurement volume of service capacity with a
bullish outlook, and accordingly the FLSPs decreased their guaranteed service quality standard properly to
satisfy the demand and prevent severely deviating the promised quality guarantee defect rate, which is
consistent with the optimal strategies of the two parties in the scenario 4 (UIR and NGCC) of this paper.
(4) After the biggest sales promotion day, Tianjin Yuantong Express made particular emergency plan and pre-
pared temporary emergency service staff and vehicles, helping those FLSPs having difficulties and ensur-
ing customers’ satisfactory. When the sales promotion finally ended, Tianjin Yuantong Express awarded or
punished each FLSP according to comparison of its actual service quality and its guaranteed service
quality.

7.4 The effect of new solutions for service capability procurement

With these service capability procurement measures above, Tianjin Yuantong Express successfully dealt with demand
boom triggered by E-commerce sale promotions in 2012. As shown in Table 3, the obvious increased total volume of
express packages on 11/11 and decreased rate of claims from 2011 to 2013 benefit from the right service capability

Table 3. The service statistics of Yuantong Express of China in November 2011–2013.

Item November 2011 November 2012 November 2013

Rate of claims (percentage of claimed package per million packages) 23.2 22.6 11.7
Total volume of express packages on 11/11 (million) 267 600 1000
506 W. Liu et al.

procurement decision under the demand updating and quality guarantee. The data in Table 3 are come from State Postal
Bureau of China (http://www.spb.gov.cn) and the website of Yuantong Express of China (http://www.yto.net.cn). Table 3
shows that compared to the rate of claims in 11/2011, the rate of claims obviously decreased in 11/2012. With the same
improving approaches extended in 2013, the rate of claims further decreased to 11.7 in 11/2013. Therefore, the case of
Yuantong Express of China practically proves that the LSSC adopting the service capability procurement strategy with
quality guarantee and demand information updating would not only help increase the actual service quality provided to
customers, but also benefit to the increased total volume of express packages.

8. Research limitations and directions for future work

There are still some limitations in this paper. For instance, two important assumptions are proposed to simplify the
model building: the market demand is assumed as a random variable that is only related with quality guarantee
defect rate, and the price is regarded as an exogenous variable; another assumption is that the FLSP bears both the
guarantee change cost and extra capacity supply cost, while more commonly, these two costs are undertaken by
both the LSI and the FLSP especially in a risk-sharing issue. In addition, the paper treats quality supervision
strength of the LSI as an exogenous variable to simplify the research process. Therefore, in the future work, the
optimal decisions may be discussed in the assumption that the logistics service demand and the actual quality
defect rate obey some more general probability distributions. It is also worthwhile for the LSI considering the qual-
ity supervision strength and the procurement quantity as its decision variables when planning the optimal procure-
ment strategies.

Acknowledgements
The suggestions of the reviewers are also gratefully acknowledged. We also express many thanks to Manager Jianfeng Zhang in
Tianjin Yuantong Express Company, China because he gave us many useful materials for case study.

Funding
This research is supported by the National Natural Science Foundation of China [grant number 71372156]; Humanity and Social
Science Youth foundation of Ministry of Education of China [grant number 2013YJC630098]; sponsored by China State Scholarship
Fund and Independent Innovation Foundation of the Tianjin University.

References

Baker, T., and D. A. Collier. 2005. “The Economic Payout Model for Service Guarantees.” Decision Sciences 36 (2): 197–220.
Benjaafar, S., W. L. Cooper, and S. Mardan. 2011. “Production-Inventory Systems with Imperfect Advance Demand Information and
Updating.” Naval Research Logistics 58 (2): 88–106.
Berk, E., Ü. Gürler, and R. A. Levine. 2007. “Bayesian Demand Updating in the Lost Sales Newsvendor Problem: A Two-moment
Approximation.” European Journal of Operational Research 182: 256–281.
Berman, B., and A. Mathur. 2014. “Planning and Implementing Effective Service Guarantee Programs.” Business Horizons 57:
107–116.
Carvell, S. A., and D. C. Quan. 2008. “Exotic Reservations – Low-price Guarantees.” International Journal of Hospitality
Management 27 (2): 162–169.
Chen, H., J. Chen, and Y. Chen. 2006. “A Coordination Mechanism for a Supply Chain with Demand Information Updating.”
International Journal of Production Economics 103 (1): 347–361.
Cheng, Y., J. Tan, and W. H. Lin. 2013. “Allocating the Cost of Empty Railcar Miles in a Dynamic Railroad Network.” International
Journal of Shipping and Transport Logistics 5 (3): 350–366.
Chiang, W., G. Cai, X. Xu, and X. Chen. 2013. “Service Guarantee and Optimal Payout Models.” International Journal of
Production Economics 141: 519–528.
Cui, A. P., W. Liu, and X. Zhang. 2008. “Capability Coordination in Logistics Service Supply Chain with Options Contract
under Stackelberg Game Model.” Proceedings of 2008 International Conference on Machine Learning and Cybernetics 7:
4051–4056.
De, P., J. B. Ghosh, and C. E. Wells. 1991. “Optimal Delivery Time Quotation and Order Sequencing.” Decision Sciences 22:
379–390.
Donohue, K. 2000. “Efficient Supply Contracts for Fashion Goods with Forecast Updating and Two Production Modes.” Management
Science 46 (11): 1397–1411.
 International Journal of Production Research 507

Fisher, M., and A. Raman. 1996. “Reducing the Cost of Demand Uncertainty through Accurate Response to Early Sales.” Operations
Research 44 (1): 87–99.
Glenn, D. W. 2004. “Returns Policies for a Pessimistic Retailer.” Working paper. University of Illinois at Urbana.
Gurnani, H., and C. S. Tang. 1999. “Note: Optimal Ordering Decisions with Uncertain Cost and Demand Forecast Updating.”
Management Science 45 (10): 1456–1462.
Hays, J. M., and A. V. Hill. 2001. “A Longitudinal Study of the Effect of a Service Guarantee on Service Quality.” Production and
Operations Management 10 (4): 405–423.
Hays, J. M., and A. V. Hill. 2006. “Service Guarantee Strength: The Key to Service Quality.” Journal of Operations Management
24 (6): 753–764.
Huang, H., S. P. Sethi, and H. Yan. 2005. “Purchase Contract Management with Demand Forecast Updates.” IIE Transactions 37:
775–785.
Iyer, Ananth V., and M. Bergen. 1997. “Quick Response in Manufacturer–Retailer Channels.” Management Science 43 (4): 559–570.
Jin, N., N. D. Line, and B. Goh. 2013. “Experiential Value, Relationship Quality, and Customer Loyalty in Full-service Restaurants:
The Moderating Role of Gender.” Journal of Hospitality Marketing & Management 22 (7): 679–700.
Kashyap, R. 2001. “The Effects of Service Guarantees on External and Internal Markets.” Academy of Marketing Science Review
10: 1–19.
Larsen, E. R., J. D. W. Morecroft, and J. S. Thomsen. 1999. “Complex Behaviour in a Production–Distribution Model.” European
Journal of Operational Research 119 (1): 61–74.
Liu, W. H. 2008. “Research on the Two-echelon Capacity Cooperation Coordination in Logistics Service Supply Chain.” Journal of
Wuhan University of Technology 30 (2): 149–153.
Liu, W., M. Ge, W. Xie, Y. Yang, and H. Xu. 2014. “An Order Allocation Model in Logistics Service Supply Chain Based on the
Pre-estimate Behaviour and Competitive-bidding Strategy.” International Journal of Production Research 52 (8): 2327–2344.
Liu, W., C. Liu, and M. Ge. 2013. “An Order Allocation Model for the Two-echelon Logistics Service Supply Chain Based on
Cumulative Prospect Theory.” Journal of Purchasing & Supply Management. 19: 39–48.
Liu, W., C. Liu, X. Xu, D. Xie, and M. Ge. 2012. “Quantity Coordination of Capacity Cooperation in Logistic Service Supply Chain:
A Comparison Study Based on Capacity Matching Constraint.” African Journal of Business Management 6 (5): 1795–1807.
Liu, W. H., and D. Xie. 2013. “Quality Decision of the Logistics Service Supply Chain with Service Quality Guarantee.”
International Journal of Production Research 51 (5): 1618–1634.
Liu, W. H., D. Xie, and X. Xu. 2013. “Quality Supervision and Coordination of Logistic Service Supply Chain under Multi-period
Conditions.” International Journal of Production Economics 142: 353–361.
Liu, W. H., X. C. Xu, Z. X. Ren, and Y. Peng. 2011. “An Emergency Order Allocation Model Based on Multi-Provider in
Two-echelon Logistics Service Supply Chain.” Supply Chain Management: An International Journal 16 (6): 390–400.
McWilliams, B., and E. Gerstner. 2006. “Offering Low Price Guarantees to Improve Customer Retention.” Journal of Retailing
82 (2): 105–113.
Milner, J. M., and M. J. Rosenblatt. 2002. “Flexible Supply Contracts for Short Life-cycle Goods: The Buyer’s Perspective.” Naval
Research Logistics 49 (1): 25–45.
Miltenburg, J., and H. C. Pong. 2007a. “Order Quantities for Style Goods with Two Order Opportunities and Bayesian Updating of
Demand. Part I: No Capacity Constraints.” International Journal of Production Research 45 (7): 1643–1663.
Miltenburg, J., and H. C. Pong. 2007b. “Order Quantities for Style Goods with Two Order Opportunities and Bayesian Updating of
Demand. Part II: Capacity Constraints.” International Journal of Production Research 45 (8): 1707–1723.
Moorthy, S., and K. Srinivasan. 1995. “Signaling Quality with a Money-back Guarantee: The Role of Transaction Costs.” Marketing
Science 14 (4): 442–466.
Nie, W., and D. L. Kellogg. 1999. “How Processors of Operations Management View Service Operations.” Production and
Operations Management 8 (3): 339–355.
Oliver, H., and J. Koeberg. 2013. “Quality Assurance: Adapting SERVQUAL to Measure the Perceived Quality of Pre-service
Teachers’ Teaching Practice Experience.” Africa Education Review 10 (sup1): S183–S206.
Özen, U., G. Sošić, and M. Slikker. 2012. “A Collaborative Decentralized Distribution System with Demand Forecast Updates.”
European Journal of Operational Research 216: 573–583.
Palaka, K., S. Erlebacher, and D. H. Kropp. 1998. “Lead Time Setting, Capacity Utilisation, and Pricing Decisions under Lead Time
Dependent Demand.” IIE Transactions 30: 151–163.
Paulley, N., R. Balcombe, R. Mackett, H. Titheridge, J. Preston, M. Wardman, J. Shires, and P. White. 2006. “The Demand for Public
Transport: The Effects of Fares, Quality of Service, Income and Car Ownership.” Transport Policy 13: 295–306.
Petruzzi, N. C., and M. Dada. 1999. “Pricing and the Newsvendor Problem: A Review with Extensions.” Operations Research
47 (2): 183–194.
Quan, D. 2002. “The Price of a Reservation.” The Cornell Hotel and Restaurant Administration Quarterly 43 (3): 77–86.
Ray, S., and E. M. Jewkes. 2004. “Customer Lead Time Management When Both Demand and Price Are Lead Time Sensitive.”
European Journal of Operational Research 153 (3): 769–781.
Sarvary, M., and V. Padmanabhan. 2001. “The Informational Role of Manufacturer Returns Policies: How They Can Help in Learning
the Demand.” Marketing Letters 12 (4): 341–350.
508 W. Liu et al.

Sethi, S. P., H. Yan, and H. Zhang. 2004. “Quantity Flexibility Contracts: Optimal Decisions with Information Updates.” Decision
Sciences 35 (4): 691–712.
Sethi, S. P., H. Yan, H. Zhang, and J. Zhou. 2007. “A Supply Chain with a Service Requirement for Each Market Signal.” Production
and Operations Management 16 (3): 322–342.
So, K. C. 2000. “Price and Time Competition for Service Delivery.” Manufacturing and Service Operations Management 2 (4):
392–409.
So, K. C., and J. S. Song. 1998. “Price, Delivery Time Guarantees and Capacity Selection.” European Journal of Operational
Research 111 (1): 28–49.
So, K. C., and X. Zheng. 2003. “Impact of Supplier’s Lead Time and Forecast Demand Updating on Retailer’s Order Quantity
Variability in a Two-level Supply Chain.” International Journal of Production Economics 86: 169–179.
Song, H., H. Yang, A. Bensoussan, and D. Zhang. 2014. “Optimal Decision Making in Multi-product Dual Sourcing Procurement
with Demand Forecast Updating.” Computers & Operations Research 41: 299–308.
Sum, C. C., and Y. S. Lee. 2002. “Modeling the Effects of a Service Guarantee on Perceived Service Quality Using Alternating
Conditional Expectations (ACE).” Decision Sciences 33 (3): 347–384.
Suwelack, T., J. Hogreve, and W. D. Hoyer. 2011. “Understanding Money-back Guarantees: Cognitive, Affective, and Behavioral
Outcomes.” Journal of Retailing 87 (4): 462–478.
Tsay, A. 1999. “The Quantity Flexibility Contract and Supplier–Customer Incentives.” Management Science 45 (10): 1339–1358.
Wirtz, J. 1998. “Development of a Service Guarantee Model.” Asia Pacific Journal of Management 15 (1): 51–75.
Yan, H., K. Liu, and A. Hsu. 2003. “Optimal Ordering in a Dual-supplier System with Demand Forecast Updates.” Production and
Operations Management 12 (1): 30–45.
Yan, X., and Y. Wang. 2014. “A Newsvendor Model with Capital Constraint and Demand Forecast Update.” International Journal of
Production Research 52 (17): 5021–5040.
Zhang, J., B. Shou, and J. Chen. 2013. “Postponed Product Differentiation with Demand Information Update.” International Journal
of Production Economics 141: 529–540.
Zhang, Z., Y. Tan, and D. Dey. 2009. “Price Competition with Service Level Guarantee in Web Services.” Decision Support Systems
47: 93–104.
Zhang, Y., and H. W. Xiao. 2011. “Couriers’ Pressure upon Thousands of Packages on ‘Singles Day’.” Accessed November 15,
2011. http://zjnews.zjol.com.cn/05zjnews/system/2011/11/15/017997639.shtml
Zhou, Y. W., and S. D. Wang. 2012. “Supply Chain Coordination for Newsvendor-type Products with Two Ordering Opportunities
and Demand Information Update.” Journal of the Operational Research Society 63: 1655–1678.

›2 pI1 ›2 pF1
Appendix 1. Proofs for ›z21
\0 and ›q21
\0

Proof The second-order derivatives of Equation (3) on z1 and q1 are as follows.

8 2 I  
< @ p21 ¼  p þ ks Uðq1 Þ lðq1 Þf ðz1 Þ þ vlðq1 Þf ðz1 Þ
@z1
 R   R 
: @ p21 ¼ b2 ebq1 z1 ðw  cF Þ  v z1 FðxÞdx A  ðb þ 1Þ2 eðbþl1Þq Ask1 z1  z1 FðxÞdx
2 F

@q 1
0 l 0
@ 2 pI1
Firstly, \0 could be proved in the following steps.
@z21
* v\w\p and ks Uðq1 Þ [ 0
) p þ ks Uðq1 Þ  v [ 0

@ 2 pI1
) ¼ ½p þ ks Uðq1 Þlðq1 Þf ðz1 Þ þ vlðq1 Þf ðz1 Þ ¼ ½p þ ks Uðq1 Þ  vlðq1 Þf ðz1 Þ\0 (A.1)
@z21
@ 2 pF1
Then \0 could be proved in following steps.
@q21
 Z z1  Z
@ 2 pF1 1 z1
2 bq1
eðbþlÞq Ask z1 
1
¼ b e z 1 ðw  c F Þ  v FðxÞdx A  ðb þ Þ2 FðxÞdx
@q21  Z0 l 0
z1
2 bq1
¼b e z1 ðw  cF Þ  v FðxÞdx A

2 0
 Z z1  Z z1
1
eðbþlÞq Ask z1  FðxÞdx b2 ebq1 z1 ðw  cF Þ  v
1
 bþ FðxÞdx A
l  Z z1 0 0
2 ðbþl1Þq
b e Ask z1  FðxÞdx (A.2)
0
* ebq1 [ eðbþlÞq , then substitute it in Equation (A.2),
1
 International Journal of Production Research 509

 Z z1
@ 2 pF1 1
2 ðbþlÞq1
) b e z1 ðw  cF Þ  v FðxÞdx A
@q21  Z z1 0  Z z1  Z z1 
1Þq
ðbþl
 b2 ebq1 Ask1 z1  FðxÞdx b2 e A z1 ðw  cF Þ  v FðxÞdx  sk1 z1 
1
FðxÞdx
1
 0 Z z1  0 0
2 ðbþlÞq1
¼b e A z1 ðw  cF  sk1 Þ  ðv  sk1 Þ FðxÞdx (A.3)
0
As sk1 [ w  cF (see Assumption 4), w − cF − τk1 < 0. However, whether v − τk1 ≥ 0 or not is uncertain, thus, the discussion is
continued under two cases.
R z1
(1) When v − τk1 ≥ 0, as z1 > 0, 0\ 0 FðxÞdx\z1 and sk1 [ w  cF , Equation (A.3) becomes obvious that
1Þq
Z z1
ðbþl
b2 e Afz1 ðw  cF  sk1 Þ  ðv  sk1 Þ
1
FðxÞdxg\0
0

Therefore, When v − τk1 ≥ 0, there is

@ 2 pF1
\0 (A.4)
@q21
R z1
(2) When v − τk1 < 0, i.e. τk1 − v > 0, as 0\ 0 FðxÞdx\z1 , so it is obvious that
Z z1
0\ðsk1  vÞ FðxÞdx\ðsk1  vÞz1
0

Then Equation (A.3) could be changed into Equation (A.5),

1 Þq
 Z z1  1Þq
ðbþl ðbþl
b e A z1 ðw  cF  sk1 Þ  ðv  sk1 Þ FðxÞdx \b2 e Afz1 ðw  cF  sk1 Þ þ ðsk1  vÞz1 g
2 1 1

0
1Þq
ðbþl
¼ b2 e Az1 ðw  cF  vÞ
1
(A.5)
1Þq
ðbþl
Plus, w  cF \m\w, thus, b2 e Az1 ðw  cF  vÞ\0. So When v − τk1 < 0, there is
1

@ 2 pF1
\0 (A.6)
@q21
@ 2 pI1 @ 2 pF1
To sum up the conclusions of Equation (A.1), (A.4) and (A.6), we can get that @z21
\0 and @q21
\0 are proved.

q 
Appendix 2. The solution process of e 2
e F2 on e
Firstly, we take the first-order derivation of p q 2 , then Equation (B.1) is obtained.
 Z z
@e
p F2 sk1 eq 2 =l e
q 2 =l be
1
¼ e  bðw  cF  sk1 e Þ e q2
A xf ðxÞdx  c (B.1)
@e
q2 l 0
eq 2
q 2 ¼ l ln t, ebeq 2 ¼ t lb . Because 0 e
Let t ¼ e l , then e q 2 1, then el t 1. So set a function of gðtÞ, let
1

 Z z
@e
p F2 sk1 lb
1
gðtÞ ¼ ¼ t  bðw  cF  sk1 tÞ t A xf ðxÞdx  c (B.2)
@e
q2 l 0
Take the first-order derivation and second-order derivation of gðtÞ on t, then

 Z z
0 1 lb lb1
1
g ðtÞ ¼ ð1 þ lbÞ þ b sk1 t  lb ðw  cF Þt
2
A xf ðxÞdx
l 0
510 W. Liu et al.

h i Z z1
g00 ðtÞ ¼ bð1 þ lbÞ2 sk1 t lb1  ðlb  1Þlb2 ðw  cF Þt lb2 A xf ðxÞdx
0
q 2 are given in different ranges.
Secondly, the figures of gðtÞ would be analysed and the optimal e

(1) The case of 0 < μβ ≤ 1

When 0 < μβ ≤ 1，g″(t) > 0，so g(t) is a strictly convex function. From g 0 ðtÞ ¼ 0 and τk1 > w − cF, we can easily get
tf ¼ lð1þlbÞ
b ðwcF Þ
2 2
2
sk
\1.
1
Because limt!0þ gðtÞ\0 and limt!þ1 1gðtÞ [ 0, so when t 2 ½0; þ1, there is one and only one solution of t which make
gðtÞ ¼ 0，we can set this t is t0 . If t0 2 ½el ; 1, then e q 2 ¼ l ln t0 ；If t0 2 ½0; el ,
1
p F2 get the maximum when e
q 2 ¼ l ln t0 , that is e
q 2 ¼ 1. If t0 2 ½1; þ1，then e
then e q 2 ¼ 0. Please see Figure B.1. When the values of the parameters in Equation (B.2) are given, t0
could be solved by interpolation method from Equation gðtÞ ¼ 0.

g (t )

t
t0

Figure B.1. The figure of gðtÞ when 0 < μβ ≤ 1.

(2) The case of μβ > 1

When μβ > 1, from g 00 ðtÞ ¼ 0, it could be easily got ts ¼ lbðlb1Þðwc
ð1þlbÞ2 sk1
FÞ
and then ts \tf \1. As to the monotonicity of gðtÞ, the
0
value of gðtÞ decreases with the increase of t 2 ð0; tf Þ (due to g ðtÞ\0), and that of gðtÞ increases with the increase of t 2 ðtf ; þ1Þ
(due to g 0 ðtÞ [ 0). Hence, gðtÞ is obtained as a strictly concave function when 0 t ts , while gðtÞ is a strictly convex function when
t [ ts . Note that limt!0þ gðtÞ\0, limt!þ1 gðtÞ [ 0 and ts \tf \1, we can get the possible curve shape as shown in Figure B.2.

g (t )

ts t f
t
t1

Figure B.2. The figure of gðtÞ when μβ > 1.

Therefore, we can find when t 2 ½0; þ1, there is one and only one solution of t which make gðtÞ ¼ 0, just let the value is t1 . If
t1 2 ½el ; 1，then e q 2 ¼ l ln t1 , if t1 2 ½0; el ，then e
1 1
p F2 get the maximum when e q 2 ¼ l ln t1 , so e q 2 = 1:; if t1 2 ½1; þ1, then
q 2 ¼ 0. When the values of the parameters in Equation (B.2) are given, t0 could be solved by interpolation method from the equation
e
gðtÞ ¼ 0.
In summary, the optimal e q 2 could be satisfied by the following formulation (B.3).
8 h 1 i
> if t 2 el ; 1
< l ln t;
>
h i
q 2 ¼
e if t 2 0; el
1
(B.3)
>
>
1;
:
0; if t 2 ½1; þ1
h i R z
sk1
where t could be solved by interpolation method from Equation gðtÞ ¼ l t  bðw  cF  sk1 tÞ t lb A 0 1 xf ðxÞdx  c ¼ 0.
Copyright of International Journal of Production Research is the property of Taylor & Francis
Ltd and its content may not be copied or emailed to multiple sites or posted to a listserv
without the copyright holder's express written permission. However, users may print,
download, or email articles for individual use.