Quality uncertainty and quality-compensation contract for supply chain coordination

Chang Hwan Lee, Byong-Duk Rhee and T.C.E. Cheng

European Journal of Operational Research, 2013, vol. 228, issue 3, 582-591

Abstract: Many firms often face quality problems, even though quality improvement has long been a competitive imperative for performance enhancement. When suppliers are the sources of quality problems, prior literature has focused on sustaining a buyer’s competitiveness given the suppliers’ quality uncertainty. Surprisingly, the literature has not paid sufficient attention to quality uncertainty from a coordination perspective. On the other hand, the literature on channel coordination has not considered quality uncertainty in designing a contract of alliance. We bridge the gap between these two streams of literature by explicitly considering quality uncertainty in a coordination framework. In contrast to the coordination literature, we show that channel integration may result in smaller order quantity and less accurate inspection than in a decentralized supply chain if product quality is uncertain. We examine the two most extensively discussed contracts for coordination, buybacks and revenue-sharing, in the presence of quality uncertainty, and find that these two contracts fail to coordinate the supply chain. We then propose a new scheme, the quality-compensation contract, in which the manufacturer compensates the retailer for defective products that are inadvertently sold to consumers, and analytically show that the contract fully coordinates the supply chain.

Keywords: Purchasing; Quality uncertainty; Imperfect inspection; Coordination; Quality-compensation contract (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (24)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:228:y:2013:i:3:p:582-591

DOI: 10.1016/j.ejor.2013.02.027

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