Coordination contract design for the newsvendor model

We design contracts to coordinate the newsvendor setting with a supplier and a retailer. Traditional approaches begin with a restricted set of contracts. However, we design mechanisms in a more general way by directly constructing payment schemes to satisfy incentive-compatibility and individual-rationality. Under symmetric information, coordinating contracts in the literature can be interpreted by this method. Under asymmetric information, we model the retailer’s private demand information as a space of either continuous or discrete states. In the continuous case, wholesale price contracts cause system inefficiency and there exists a unique optimal wholesale price for the supplier if the distribution of forecast error has IFR (Increasing Failure Rate) property. We further characterize the structure of coordinating payment, and find that the set of coordinating contracts is restricted to special two-part tariffs where wholesale price equals unit production cost. In the discrete case, contrary to expectation, linear wholesale price contracts achieve coordination. With demand forecast distributed more and more densely on its support, the interval of coordinating wholesale prices gradually shrinks to the unit production cost.