An analysis of contract form for supply chains with quality improvement

Abstract

Abstract This study examines different contract forms for the supply chain with quality improvement decision and retailer price decision. We consider three types of quality improvement: cost consuming, cost identical, and cost saving, which correspond to the cases in which quality improvement leads to an increment, no change, and a decrease in production cost, respectively. We compare the performance of two types of quality contracts: (1)pay‐before‐performancecontract, under which the supplier receives monetary support from the buyer before exerting quality improvement effort; and (2)pay‐after‐performancecontract, under which the supplier receives monetary compensation based on the outcome of effort. We find that the performance of each contract depends on the types of quality improvement. Further, the pay‐after‐performance contract leads to close‐to‐perfect contract efficiency and dominates the pay‐before‐performance contract from the supplier's perspective in most cases. However, this result does not apply in two extended cases: when there are multiple competing suppliers, the pay‐before‐performance contract can dominate the pay‐after‐performance contract if quality improvement is cost consuming; and when the buyer can exert sales effort, neither contract can achieve close‐to‐perfect efficiency in most cases.

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