Coordination of a Random Yield Supply Chain with a Loss-Averse Supplier

Abstract

This paper investigates the coordination of a supply chain consisting of a loss-averse supplier and a risk-neutral buyer who orders products from the supplier who suffers from random yield to meet a deterministic demand. We derive the risk-neutral buyer's optimal order policy and the loss-averse supplier's optimal production policy under shortage-penalty-surplus-subsidy (SPSS) contracts. We also analyze the impacts of loss aversion on the loss-averse supplier's production decision making and find that the loss-averse supplier may produce less than, equal to, or more than the risk-neutral supplier. Then, we provide explicit conditions on which the random yield supply chain with a loss-averse supplier can be coordinated under SPSS contracts. Finally, adopting numerical examples, we find that when the shortage penalty is low, the buyer's optimal order quantity will increase, while the supplier's optimal production quantity will first decrease and then increase as the loss aversion level increases. When the shortage penalty is high, the buyer's optimal order quantity will decrease but the supplier's optimal production quantity will always increase as the loss aversion level increases. Furthermore, the numerical examples provide strong evidence for the view that SPSS contracts can effectively improve the performance of the whole supply chain.