Coordination mechanisms of a three-layer supply chain under demand and supply risk uncertainties

Abstract

This paper considers a newsvendor model for a single product to focus on the importance of coordination under demand and supply uncertainties where the raw materials are procured from two unreliable suppliers without any emergency resource; the main supplier (which is cheaper but more unreliable) is prone to random supply disruption and, therefore, it can satisfy all or nothing of the buyer's order, while the backup supplier (which is expensive but less unreliable) is prone to random yield and, therefore, can satisfy only a random fraction of the buyer's order. From the numerical results, we observe that it would be optimal to over-utilize the backup supplier and under-utilize the main supplier if the maximum growth in supply risk results from supply disruption. On the other hand, when the growth in supply risk occurs mainly due to increase in yield risk, the optimal risk mitigation strategy would be to increase the use of the backup supplier and decrease the use of the main supplier. We propose the price only contract and a new revenue sharing contract to mitigate demand and supply uncertainties in the decentralized model, and observe that the revenue sharing contract can fully coordinate the supply chain with win-win outcome for all entities involved in the supply chain.