Contract Preferences and Performance for the Loss-Averse Supplier: Buyback vs. Revenue Sharing

Abstract

Prior theory claims that buyback and revenue-sharing contracts achieve equivalent channel-coordinating solutions when applied in a dyadic supplier–retailer setting. This suggests that a supplier should be indifferent between the two contracts. However, the sequence and magnitude of costs and revenues (i.e., losses and gains) vary significantly between the contracts, suggesting the supplier’s preference of contract type, and associated contract parameter values, may vary with the level of loss aversion. We investigate this phenomenon through two studies. The first is a preliminary study investigating whether human suppliers are indeed indifferent between these two contracts. Using a controlled laboratory experiment, with human subjects taking on the role of the supplier having to choose between contracts, we find that contract preferences change with the ratio of overage and underage costs for the channel (i.e., the newsvendor critical ratio). In particular, a buyback contract is preferred for products with low critical ratio, whereas revenue sharing is preferred for products with high critical ratio. We show these results are consistent with the behavioral tendency of loss aversion and are more significant for subjects who exhibit higher loss aversion tendencies in an out of context task. In the second (main) study, we examine differences in the performance of buyback and revenue-sharing contracts when suppliers have the authority to set contract parameters. We find that the contract frame influences the way parameters are set and the critical ratio again plays an important role. More specifically, revenue-sharing contracts are more profitable for the supplier than buyback contracts in a high critical ratio environment when accounting for the supplier’s parameter-specification behavior. Also, there is little difference in performance between the two contracts in a low critical ratio environment. These results can help inform supply managers on what types of contracts to use in different critical ratio settings. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2182 . This paper was accepted by Martin Lariviere, operations management.

Sustainability Analysis of Supply Chains with Fashion Products under Alternative Power Structures and Loss-Averse Supplier

“…Reference [28] investigate how the uncertainty level embedded in market demand affects the applicability of buy-back contracts in a supplier-retailer supply chain. Reference [12] empirically compare the performance of supply chain coordination of a supply chain with revenue sharing contract and that with buy-back contract when the supplier is loss-averse. Reference [6] studies supply chain coordination by considering variable back orders, inspections and discount policy.…”

“…For the ease of presentation, we summarize the contribution of the references cited above in Table 1. Zhang et al [12] √ √…”

“…The supplier offers its brand name apparel to the retailer at a contracted wholesale price, and the retailer faces to the uncertain demand in the consumer market. The retail price is assumed to be exogenous and be the market price [12], and the salvage value is assumed to be zero (This assumption can be reasonable because fast-fashion products are innovative, fast-changing and have a short selling season. Previous literature on fashion supply chain has widely made this assumption, e.g., [9,29,30]).…”

“…Because the supplier allows the retailer to return the unsold inventory, it bears the major part of the risk of demand uncertainty as it still has to deal with the leftover apparel. Thus, our analysis can be divided into two cases according to the supplier's attitude to loss: loss-neutral and loss-averse which is similar to [12]. Then, there are in total four scenarios with the combination of the channel power structures and the supplier's attitude to loss, as shown in the Table 2: Table 2.…”

“…Due to the highly uncertain demand in the fashion industry, buy-back contracts are widely provided by the suppliers, i.e., the unsold inventory of the retailer at the end of the selling season can be returned to the supplier [9][10][11]. Then, the demand risk is shared between the supplier and the retailer, and the supplier's attitude towards loss becomes important [12].…”