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Contract design for risk sharing partnerships in manufacturing

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  • Buzacott, John A.
  • Steve Peng, H.

Abstract

The development of extensive partnerships with suppliers has become a characteristic of manufacturing, particularly in the aircraft and automobile industries. This paper considers the development of appropriate contracts that enable market risks to be shared between the lead manufacturer and the partners. It is shown that it is usually appropriate to have threshold contracts, i.e., contracts where a partner only shares in profits if sales exceed a value determined by risk tolerance and target return. The value of having financial partners as well as manufacturing partners is demonstrated, although it is also shown that financial partner contributions to the project should be limited. We also consider the situation where partners have pre-existing commitments to other projects, perhaps with competitors. The producers sales may be correlated with the partners profits on pre-existing commitments so the impact on contract structure is explored. It is shown that even if a partner had preexisting commitments whose profit is positively correlated with product sales then it is often beneficial to use such a partner.

Suggested Citation

  • Buzacott, John A. & Steve Peng, H., 2012. "Contract design for risk sharing partnerships in manufacturing," European Journal of Operational Research, Elsevier, vol. 218(3), pages 656-666.
    • Handle: RePEc:eee:ejores:v:218:y:2012:i:3:p:656-666
    DOI: 10.1016/j.ejor.2011.12.008
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    References listed on IDEAS

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    1. Alan MacPherson & David Pritchard, 2007. "Boeing’s Diffusion of Commercial Aircraft Technology to Japan: Surrendering the U.S. Industry for Foreign Financial Support," Journal of Labor Research, Springer, vol. 28(3), pages 552-566, July.
    2. John Buzacott & Houmin Yan & Hanqin Zhang, 2011. "Risk analysis of commitment–option contracts with forecast updates," IISE Transactions, Taylor & Francis Journals, vol. 43(6), pages 415-431.
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    Cited by:

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    2. Collings, David & Corbet, Shaen & Hou, Yang (Greg) & Hu, Yang & Larkin, Charles & Oxley, Les, 2022. "The effects of negative reputational contagion on international airlines: The case of the Boeing 737-MAX disasters," International Review of Financial Analysis, Elsevier, vol. 80(C).
    3. He Yiming & Luo Biliang & Zou Baoling, 2018. "Do Heterogeneous Agricultural Factors Affect Farmland Contractual Choice?—Evidence from China," Man and the Economy, De Gruyter, vol. 5(1), pages 1-12, June.
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    5. Herbon, Avi & Tsadikovich, Dmitry, 2023. "An efficient entropy-based stopping rule for mitigating risk factors in supply nets," International Journal of Production Economics, Elsevier, vol. 260(C).

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