Buy back contracts

The chapter studies a supply chain consisting of one supplier and one retailer with satisficing objectives for each player. The authors examine the supply chain under three types of contracts wholesale price, buy back, and quantity flexibility contracts. They show that under the satisficing objectives, wholesale price contracts can coordinate the supply chain, whereas buy back contracts cannot. In addition, quantity flexibility contracts must degenerate into wholesale price contracts to coordinate the supply chain. The authors also discuss possible extensions to their model. 

To control production cost, procurement, processing, energy, and human resource (compared to outsourcing) costs at each step of the supply chain must be minimized. To cut procurement cost, suppliers must be evaluated based on on-time delivery, low unit cost, and a low defective rate (refer to Chap. 4). Buy back contracts reduce the buyer s risk in unused compmients. To cmitrol productiOTi cost, it is imperative not to produce defective parts. The root causes of defects in products must be identified and the associated problems resolved. Craisumption of power, water, and other utihties must be controlled, and recruiting, training, and retention of workers must be a high priority. 

The buyer would have several options to counter market volatility purchase-postponement, buy-back contract, and use hedging options such the option-to-purchase . The buyer gains by postponing purchase of the items to a time when demand becomes known. This would require the supplier to hold inventory that... 

To protect against the downside market risk, the buyer may implement a buy-back contract to share the risk of unused items with the supplier. This would permit the buyer to return unsold or unused goods to the supplier at a unit price negotiated by the two parties. 

For emergency relief, contracts must reflect the uncertainties of disasters. This can be achieved in multiple ways. Instead of a fixed delivery time, the buyer can require supplies to be delivered at a time (to be specified by buyer) within a time window. The buyer may also insist that they should be able to change the order quantity, if needed and vary the wholesale price within some botmd. Buyer can buy insurance or financial options to hedge against demand volatility. Buy back contracts, where unsold items can be returned by the supplier at a discounted price, leads to sharing of demand risk by both buyer and supplier. 

Another consideration when working with a contract manufacturer is whether specialized or dedicated processing equipment will be required. If dedicated or special equipment is required, the contract manufacturer may feel justified to ask the client to supply this equipment with or without a later buy-back arrangement. In a buy-back arrangement, the contractor asks the client to initially assume the full risk of loss of the capital investment in the equipment should the product not become a viable commercial entity. However, as the product successfully completes each stage of the steps to marketability, the client s capital investment would be gradually returned. The end result is that the contract manufacturer has all of the equipment needed for the manufacture of commercial-sized batches of the client s product at the time it is finally commercialized. 

Muchofthe re search has assumedthateach agent in a supply chain is risk-neutral and his objective is to maximize (minimize) the expected profit (cost). Under this assumption, a supply chain is said to be coordinated when the summation of individual expectedprofits (costs) are maximized (minimized). A number of contractual forms have been studied recently under the risk-neutral assumption. These include the three popular contracts wholesale price (WP) contracts (Lariviere Porteus, 2001 Corbett et al., 2004), buy back (BB) contracts (Pasternack, 1985), and quantity flexibility (QF) contracts (Tsay, 1999 Cachon, 2003). 

With WP contracts, the suppliertakes no risk from the demand uncertainty. With BB contracts, the supplier charges aunitwholesale price w, butoffers the retailer a unit buy back price h for all of the unsold units. Therefore, with BB contracts, the suppliertakes part ofthe risk from demand uncertainty. Each BB contract can be characterized by a parameter set 6 = w, b. To avoid uninteresting scenarios, we assume that v[Pg.239]

It is worthwhile noticing that the contract parameters yv,b) need to be chosen such that w-(c-v) second inequality is to prevent the retailer from profiting through the buy back process. Similarly, since the supplier s marginal revenue and the marginal cost are w - and c-v, respectively, the first inequality prevents the supplier from profiting through the buy back process. 

Notice that wholesale price w in aBB contract plays m important role for the contract to be Pareto optimal. When c upper bound w in order for the BB contraet to be Pareto optimal. On the other hand, when wlower bound w - c-v) m order for the BB eontractto be Pareto optimal. When w = iD, the BB contract is Pareto optimal regardless of the buy back price b, as long as the general requirement of w - (c - v) < b < w holds. 

RISK SHARING THROUGH BUYBACKS A buyback or returns clause allows a retailer to return unsold inventory up to a specified amount, at an agreed-upon price. In this case, the supplier is sharing risk by agreeing to buy back unsold inventory at the retailer. In a buyback contract, the manufacturer specifies a wholesale price c along with a buyback price b at which the retailer can return any unsold units at the end of the season. We assume that the manufacturer can salvage % for any units that the retailer returns. The manufacturer has a cost of v per unit produced. The retail price is p. 

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