Contracting under asymmetric holding cost information in a serial supply chain with a nearly profit maximizing buyer

Abstract

Screening contracts (or non-linear "menu of contracts") are frequently used for aligning the incentives in supply chains with private information. In this context, it is assumed that all supply chain parties are strictly (expected) profit maximizing and, therefore, sensible to even arbitrarily small pay-off differences between contract alternatives. However, previous behavioral work on contracting under asymmetric information in supply chains shows that agents (buyers) are not always strictly profit maximizing. Instead, they sometimes tend to choose contracts that have only a minor impact on their own performance but a substantially negative impact on the principal's (supplier's) and the overall supply chain's performance. Thus, these studies indicate that the buyers are in fact not strictly but only nearly profit maximizing when making their contract choices. The present work relaxes the assumption of the strictly profit maximizing buyer in a serial supply chain for a lotsizing framework with asymmetrically distributed holding cost information and deterministic end-customer demand. The study provides researchers and managers an approach on how to account for the buyer's insensitivity to arbitrarily small pay-off differences while providing a solution method for the resulting non-linear mathematical program. A numerical study compares the advantages of the "behavioral robust" contract assuming only nearly profit maximizing buyers against the classical screening contract assuming strictly profit maximizing buyers. The results highlight that supply chain performance losses can be substantially reduced under the behavioral robust contract.