Supply chain coordination through capacity reservation contract and quantity flexibility contract

This study considers a supply chain consisting of two independent agents, a manufacturer and a retailer. The demand and the price of the product are both uncertain, whereas capacity cost is high and capacity lead time is long. As a result, the manufacturer may not have the incentive to expand capacity if the retailer does not share the risk with her. This result induces a lower performance of the supply chain. We propose two types of contracts, i.e., capacity reservation contract and quantity flexibility contract, as risk-sharing mechanisms to encourage the manufacturer to expand the capacity and improve the overall performance of the supply chain. We find that when supply chain coordination is not achieved, our contracts can bring more system profit than other contracts with less flexibility. We further show that by setting elaborate parameters, the two contracts can coordinate the supply chain so that the total profit in the decentralized supply chain is the same as that in the centralized system. Furthermore, we compare the two contracts in terms of capacity and profits. We also show that the retailer prefers the quantity flexibility contract under coordination. Our conclusions are robust when the demand and retail price are correlated.