MANAGING THE SUPPLY CHAIN: The Definitive Guide for the Business Professional by David Simchi-Levi & Philip Kaminsky & Edith Simchi-Levi

Author:David Simchi-Levi & Philip Kaminsky & Edith Simchi-Levi
Language: eng
Format: epub
Publisher: McGraw-Hill
Published: 2004-03-05T16:00:00+00:00

6.6 SUPPLY CONTRACTS

The preceding discussion of procurement strategies emphasized the need, in many cases, to develop relationships with suppliers. These relationships can take many forms, both formal and informal, but often, to ensure adequate supplies and timely deliveries, buyers and suppliers agree on supply contracts. These contracts address issues that arise between a buyer and a supplier, whether the buyer is a manufacturer purchasing raw materials from a supplier or a retailer purchasing manufactured goods from a manufacturer. In a supply contract, the buyer and supplier may agree on

• Pricing and volume discounts

• Minimum and maximum purchase quantities

• Delivery lead times

• Product or material quality

• Product return policies

In most cases, each party, i.e., the buyer or the supplier, makes decisions with very little regard to the impact of its decisions on the other party or on supply chain performance. For instance, distributors focus on their own costs and risks and will try to reduce those as much as possible. For these reasons, distributors order small quantities and concentrate on selling what they have in their distribution centers (DCs), rather than on what the manufacturer offers.

Interestingly, in the last few years many academic researchers and industry practitioners have recognized that supply contracts are a powerful method that can be used for far more than to ensure adequate supply of and demand for goods. Indeed, recently, new contracts have been designed and used to enable supply chain parties not only to ensure adequate supply and demand for goods, but also to improve supply chain performance. This is achieved by a variety of contracts that allow risk sharing between suppliers and distributors and hence increases profit for both.

To illustrate the importance and impact of different types of supply contracts on supply chain performance, consider a typical two-stage supply chain consisting of a retailer and a supplier. The sequence of events in such a supply chain is as follows. The retailer starts by generating a forecast, determines how many units to order from the supplier, and places an order to the manufacturer so as to optimize its own profit; the manufacturer reacts to the order placed by the retailer. Recall that this process is referred to as a sequential supply chain optimization because decisions are made sequentially. Thus in a sequential supply chain each party determines its own course of action independent of the impact of its decisions on other parties. As we observed in Chapter 1, this cannot be an effective strategy for supply chain partners.

It is natural to look for mechanisms that enable supply chain entities to move beyond this sequential process and toward global optimization. More specifically, are there mechanisms that the supply chain parties can use to improve each participant’s profits? To answer this question, observe that in typical sequential supply chains such as the one described previously, the retailer assumes all the risk of having more inventory than sales, whereas the manufacturer takes no risk. Indeed, since the manufacturer takes no risk, the manufacturer would like the retailer to

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