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(c) Yossi Sheffi, MIT1 Supply Contracts Yossi Sheffi Mass Inst of Tech Cambridge, MA ESD.260J,15.770J, 1.260J.

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Presentation on theme: "(c) Yossi Sheffi, MIT1 Supply Contracts Yossi Sheffi Mass Inst of Tech Cambridge, MA ESD.260J,15.770J, 1.260J."— Presentation transcript:

1 (c) Yossi Sheffi, MIT1 Supply Contracts Yossi Sheffi Mass Inst of Tech Cambridge, MA ESD.260J,15.770J, 1.260J

2 (c) Yossi Sheffi, MIT2 Outline Supply contracts Wholesale contracts Buyback contracts Revenue sharing contracts Option contracts

3 (c) Yossi Sheffi, MIT3 The Scenario: Contract is negotiated Retailer places order (a single period) Supplier makes and sends the stuff The selling season takes place Accounting (sales, salvage, etc.)

4 (c) Yossi Sheffi, MIT4 Consumer Demand

5 (c) Yossi Sheffi, MIT5 Demand Distribution

6 (c) Yossi Sheffi, MIT6 Notations:

7 (c) Yossi Sheffi, MIT7 Wholesale Contracts Prices and costs: Supplier has a cost to make/purchase (C=$50) Supplier is selling and retail is buying at a wholesale price (W=$135) Retailer is selling for a retail price (R=$200) Retailer can salvage (S=$10) Retailer is facing a Newsboy problem and suppliers profit is trivial Excel: Supply Contracts

8 (c) Yossi Sheffi, MIT8 Wholesale Price Contract

9 (c) Yossi Sheffi, MIT9 Wholesale Price Contract Expected Profits

10 (c) Yossi Sheffi, MIT10 Wholesale Price Contract Exp Profits (Normal Approx)

11 (c) Yossi Sheffi, MIT11 Effects of Wholesale Price on Profits

12 (c) Yossi Sheffi, MIT12 Optimal Retail Order as a Function of the Wholesale Price

13 (c) Yossi Sheffi, MIT13 Wholesale Price Contract Coordination the Channel W = C

14 (c) Yossi Sheffi, MIT14 Buyback Contract The problem: how can the supplier convince the retailer to move towards the optimal order size? The supplier offer to the retailer to buy back all unsold items ($B/item). For the retailer – this is like a higher salvage value, so he will order more. The supplier now shares in the overage risk (he can still salvage, though, at the same price). Note: supplier may simply pay ($B-$S) rather than actually buy back (unless he has a better use for it)

15 (c) Yossi Sheffi, MIT15 Buyback Contract Calculations

16 (c) Yossi Sheffi, MIT16 Channel profit with Buyback

17 (c) Yossi Sheffi, MIT17 Optimal Buyback and Wholesale price Higher wholesale price requires a ______ buyback rate As the wholesale price (and the buyback rate) grows the suppliers share of the profit _______ Wholesale price ranges from $50 (supplier s cost) to $200 (retail price) Buyback rate ranges from $10 (salvage value) to $200.

18 (c) Yossi Sheffi, MIT18 Expected Profits with Buyback Contract

19 (c) Yossi Sheffi, MIT19 Optimal Buyback Price

20 (c) Yossi Sheffi, MIT20 Channel Coordination with Buyback At w=$135: B=$118, %retailer = 43%

21 (c) Yossi Sheffi, MIT21 Expected Profit with Coordinating Buyback Rate

22 (c) Yossi Sheffi, MIT22 Buyback Contracts in Practice Book publishing Periodicals/newspapers Price support in consumer electronics

23 (c) Yossi Sheffi, MIT23 Revenue Sharing Supplier still needs to get the retailer to order more Another risk-sharing scheme: supplier lowers the wholesale price but takes a percentage (1-p) of the revenue Question: how to choose W and p so the retailer will order the optimal Amount Note: wholesale price has to be lower than the suppliers cost.

24 (c) Yossi Sheffi, MIT24 The Players Paramount Blockbuster

25 (c) Yossi Sheffi, MIT25 The Economics of Revenue Sharing

26 (c) Yossi Sheffi, MIT26 Revenue Sharing

27 (c) Yossi Sheffi, MIT27 Expected Profit with Revenue Sharing

28 (c) Yossi Sheffi, MIT28 Optimal Revenue Share

29 (c) Yossi Sheffi, MIT29 Coordination with Rev. Sharing

30 (c) Yossi Sheffi, MIT30 Revenue Sharing (Normal Approx)

31 (c) Yossi Sheffi, MIT31 Real Options The retailer buys Q call options at a price w. The supplier makes Q items. Each option can be exercised at a unit price E. As demand materializes the retailer can take deliveries at a price E. No more than Q items can be bought from the supplier

32 (c) Yossi Sheffi, MIT32 Real Options

33 (c) Yossi Sheffi, MIT33 Coordination with Real Options Retailers optimal order: Comparing to a single channel: Where: The condition below is for p to be positive (so the exercise price plus the option is bigger than the option alone)

34 (c) Yossi Sheffi, MIT34 Coordination with Real Options

35 (c) Yossi Sheffi, MIT35 Expected Profits with Options

36 (c) Yossi Sheffi, MIT36 Summary Wholesale contracts give too much risk and not enough expected reward to the retailer To make the retailer order more (and increase the channels profit) the supplier has to take on part of the risk Risk sharing mechanisms covered include: Buybacks; revenue sharing, option contract Other mechanisms Quantity-flexibility (refund on a portion of the unsold units) Sales-rebate (rebate on unsold units above a threshold) There are many other mechanisms Each mechanism can coordinate the channel with various allocations of the profit between the retailer and the supplier.

37 (c) Yossi Sheffi, MIT37 Any Questions? Yossi Sheffi

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