Flexible contract design for VMI supply chain with service-sensitive demand: Revenue-sharing and supplier subsidy

Abstract To coordinate a VMI (vendor-managed inventory) supply chain with service-level sensitive customers, we relate retailer's service level to customer demand. We establish the dynamic game relationship under a revenue-sharing contract. A pure revenue-sharing contract, focusing on revenue-sharing ratio, often forms a competitive relationship among SC members, as the optimal sharing ratio is determined by the game leader and may fail to optimize SC performance. An improved mechanism is necessary to avoid sub-optimality. In this research, we propose three flexible subsidy contracts for VMI supply chains: (i) subsidizing all surplus products; (ii) subsidizing the inventory that exceeds the target level and unsold; (iii) subsidizing the inventory that exceeds target regardless it is sold or not. These contracts help SC members to arrive at optimal price, revenue-sharing ratio, inventory target, subsidy rate; and to commit inventory early. The proposed mechanism can better ensure SC collaboration, and bring the SC to Pareto improvement by allowing members to negotiate, share profit, subsidize suppliers for their risks, and select from alternative contracts under each VMI setting. They enhance service levels, maximize SC performance, and share SC profits fairly. Numerical examples are provided to validate our findings and to derive managerial implications.