Production cost functions and demand uncertainty effects in price-only contracts

Dorit S. Hochbaum and Michael R. Wagner

IISE Transactions, 2015, vol. 47, issue 2, 190-202

Abstract: The price-only contract is the simplest and most common contract between a supplier and buyer in a supply chain. In such a contract, the supplier proposes a fixed wholesale price, and the buyer chooses a corresponding order quantity. The buyer’s optimal behavior is modeled using the Newsvendor model and the supplier’s optimal behavior is modeled as the solution to an optimization problem. This article explores, for the first time, the impact of general production costs on the supplier’s and buyer’s behavior. It is revealed that increased supplier’s production efficiency, reflected in lower marginal production costs, increases the buyer’s optimal profit. Therefore, a buyer would always prefer the more efficient supplier. A higher supplier efficiency, however, may or may not increase the supplier’s optimal profit, depending on the production function’s fixed costs. The effect of demand uncertainty, as measured by the coefficient of variation, is shown to increase the optimal order quantity. The uncertainty effect on the firms’ optimal profits is analyzed. Also, the relationship between production efficiency and the response to demand uncertainty is explored and it is shown that a higher efficiency level increases the responsiveness and volatility of the supplier’s production quantities. Thus, higher-efficiency suppliers are better positioned to respond to changes in the demand uncertainty in the supply chain.

Date: 2015
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://hdl.handle.net/10.1080/0740817X.2014.938843 (text/html)
Access to full text is restricted to subscribers.

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:taf:uiiexx:v:47:y:2015:i:2:p:190-202

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/uiie20

DOI: 10.1080/0740817X.2014.938843

Access Statistics for this article

IISE Transactions is currently edited by Jianjun Shi

More articles in IISE Transactions from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().