Impact of uncertainty ascribed to defective products on supply chains

Abstract

Traditional inventory management has considered when and how much to order against the uncertainty of demand. Although many studies on inventory management have presumed that quality of products received from manufacturers is perfect, defective products would be, in actual, contained in the procurement to retailers. The inclusion of defective products causes the uncertainty in supply. The retailer does not necessarily require being responsible for all the loss by overstock and shortage of products due to the uncertainty ascribed to the inclusion of defective products. The purpose of this paper is to investigate the impact of the uncertainty ascribed to the inclusion of defective products on a supply chain. This paper first has formulated a simple supply chain model with defective products composed of the manufacturer and retailer. The model has made it clear how the uncertainty ascribed to the inclusion of defective products has an impact on the order quantity and respective profits. Then, this paper has discussed a method of assessing a latent loss as a monetary value. Combining contract techniques and game theory, this paper has proposed a contracting method that the manufacturer compensates the retailer for the latent loss to maintain a supply chain partnership.