Channel Coordination for a Supply Chain with a Risk-Neutral Manufacturer and a Loss-Averse Retailer

This article considers a decentralized supply chain in which a single manufacturer is selling a perishable product to a single retailer facing uncertain demand. It differs from traditional supply chain contract models in two ways. First, while traditional supply chain models are based on risk neutrality, this article takes the viewpoint of behavioral principal–agency theory and assumes the manufacturer is risk neutral and the retailer is loss averse. Second, while gain/loss (GL) sharing is common in practice, there is a lack of analysis of GL-sharing contracts in the supply chain contract literature. This article investigates the role of a GL-sharing provision for mitigating the loss-aversion effect, which drives down the retailer order quantity and total supply chain profit. We analyze contracts that include GL-sharing-and-buyback (GLB) credit provisions as well as the special cases of GL contracts and buyback contracts. Our analytical and numerical results lend insight into how a manufacturer can design a contract to improve total supply chain, manufacturer, and retailer performance. In particular, we show that there exists a special class of distribution-free GLB contracts that can coordinate the supply chain and arbitrarily allocate the expected supply chain profit between the manufacturer and retailer; in contrast with other contracts, the parameter values for contracts in this class do not depend on the probability distribution of market demand. This feature is meaningful in practice because (i) the probability distribution of demand faced by a retailer is typically unknown by the manufacturer and (ii) a manufacturer can offer the same contract to multiple noncompeting retailers that differ by demand distribution and still coordinate the supply chains. Subject Areas: Buyback Contract, Gain/Loss Sharing, Loss Aversion, Supply Chain Contracts and Incentives, and Supply Chain Coordination.