Operational strategies for supplier and retailer with risk preference under VMI contract

Under a vendor managed inventory contract, the retailer offers a price she would pay the manufacturer for each unit of the product. Based on the unit price that was offered, the manufacturer decides the quantity to send to the retailer before the start of the selling season. The retailer only pays for the units that were sold by the end of the selling season; leftover inventory are returned to the manufacturer. The higher the price the retailer offers to the manufacturer, the more inventory the retailer would receive. But when the retailer increases the price she offers to the manufacturer, effectively she decreases her per unit profit from selling the product. In this paper, the manufacturer is risk-neutral and so his sole objective is to maximize his expected profit. The retailer exhibits risk preferences, and therefore maximizes her expected utility. We characterize the demand condition and minimum product selling price required for the retailer to engage in a VMI contract. We also derive the analytical solution for the retailer׳s optimal purchase price to offer to the manufacturer. Furthermore, we show analytically and numerically that the risk-averse retailer offers a lower price to the manufacturer than their risk-neutral counterpart. Interestingly, we find that as the product selling price increases, the retailer does not necessarily increase the purchase price offered to the manufacturer. We also observe that some degree of demand variability can actually increase the manufacturer׳s expected profit.