Implications of Renegotiation for Optimal Contract Flexibility and Investment

Erica L. Plambeck () and Terry A. Taylor ()
Additional contact information
Erica L. Plambeck: Graduate School of Business, Stanford University, Stanford, California 94305
Terry A. Taylor: Haas School of Business, University of California, Berkeley, California 94720

Management Science, 2007, vol. 53, issue 12, 1872-1886

Abstract: In a stylized model of biopharmaceutical contract manufacturing, this paper shows how the potential for renegotiation influences the optimal structure of supply contracts, investments in innovation and capacity, the way scarce capacity is allocated, and firms' resulting profits. Two buyers contract for capacity with a common manufacturer. Then, the buyers invest in innovation (product development and marketing) and the manufacturer builds capacity. Finally, the firms may renegotiate to allow a buyer facing poor market conditions to purchase less than the contractual commitment and a buyer facing favorable conditions to purchase more. We show that renegotiation can greatly increase the firms' investments and profits, provided that the contracts are designed correctly. Failing to anticipate renegotiation leads to contracts that allow too much flexibility in the buyer's order quantity, and perform poorly relative to contracts designed to anticipate renegotiation. We provide clear conditions under which quantity flexibility contracts with renegotiation coordinate the system. Where quantity flexibility contracts fail, employing tradable options improves performance.

Keywords: renegotiation; biform games; bargaining; contract manufacturing; capacity pooling and allocation; quantity flexibility contracts (search for similar items in EconPapers)
Date: 2007
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (29)

Downloads: (external link)
http://dx.doi.org/10.1287/mnsc.1070.0731 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:53:y:2007:i:12:p:1872-1886

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().