Flexible carrier–forwarder contracts for air cargo business

Diwakar Gupta is a Professor and Director of Graduate Studies for the ISyE Graduate Program at the University of Minnesota. Diwakar received his PhD in Management Sciences from the University of Waterloo and taught at the McMaster University's DeGroote School of Business before joining the University of Minnesota. His research interests are in the area of stochastic models for service/ production systems, supply chains, and health care delivery systems. Passenger airlines (carriers), who carry nearly two-thirds of the worldwide airfreight, sell a significant portion of their cargo space through intermediaries called freight forwarders. Carriers also sell directly to shippers. In a typical carrier–forwarder contract, which can remain in effect anywhere from a few months to a year, a certain amount of capacity on specific recurring flights is preallocated (guaranteed) to the forwarder at a negotiated price per unit of capacity. Carriers often find it difficult to obtain full payment from the forwarders who typically pay freight charges only for the space actually used. Guaranteed allocations provide an incentive to forwarders to exert a greater effort on attracting demand. They, however, limit a carrier's ability to realise the highest possible revenue from cargo capacity. In this paper, we propose two flexible schemes that fall within the general contracting framework prevalent in the air cargo business. In the first scheme, the carrier determines an upfront fixed fee for reserving capacity but the freight rate is exogenous, whereas in the second scheme, there is no reservation fee, but the carrier chooses the freight rate. In both instances, we allow the carrier to adjust contract parameters, based on realised demand, a short time before the flight departs. Only those contract parameter adjustments that do not make the forwarder financially worse off are permitted. We show that this flexibility allows the carrier to achieve an efficient capacity allocation to the forwarder and the direct-ship demand streams under both mechanisms. Moreover, a carrier that charges a deposit for guaranteed allocation can induce the forwarder to simultaneously choose the optimal effort level and earn maximum profit. INTRODUCTION The air-cargo business, a 40bn dollar industry worldwide, is increasingly a significant source of revenue for passenger airlines that carry nearly two-thirds of the worldwide airfreight either on passenger flights or on freight-only flights. This industry is forecasted to grow at an average annual rate of 6.4 per cent over the next two decades (see Boeing Company, 2005). Factors such …