Supply chain benefits from inventory flexibility through adjustment contracts

In this research, we study a general multi-period inventory model for a buyer and his supplier. We propose an adjustment contract to allow the buyer to adjust his inventory levels upwards or downwards. Thus, the buyer has more flexibility in inventory control so as to reduce his inventory risk. The flexibility, however, comes at a higher price per unit of inventory. For the buyer with a wholesale price contract and the adjustment contract, we characterize the structure of the optimal inventory control policy for a general model with multiple adjustment opportunities in each period. We then formulate a Stackelberg game between the buyer and his supplier for a single period model. We demonstrate that the adjustment contract can be designed to achieve Pareto-improvement. We also show that the supply chain can be coordinated with the wholesale price contract and the adjustment contract. Moreover, we consider offering some additional incentives to the supplier, in order to motivate him to participate to achieve coordination. The incentives we consider include a premium with a participation constraint and a revenue sharing scheme. With both of these types of incentives, channel coordination can be achieved and, more importantly, the supply chain profit can be appropriately allocated between the buyer and the supplier. Additionally, we study a Stackelberg game between a supplier and two buyers for a single period model. For this more complex decentralized supply chain, we demonstrate that both Pareto-improvement and coordination can be achieved. To the best of our knowledge, we believe that our model is the first attempt to allow the adjustment of inventory levels either upwards or downwards in a multi-period inventory model. Therefore, this research will provide important contributions to both the theoretical analysis of supply chain contracts and supply chain coordination and managerial practice.