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Strategic Commitments for an Optimal Capacity Decision Under Asymmetric Forecast Information

Department of Management Science and Engineering, Stanford University, Stanford, California 94305
Morgan Stanley, 20 Cabot Square, Canary Warf, London, United Kingdom
oozer{at}stanford.edu
wei.wei{at}morganstanley.com

We study the important problem of how to assure credible forecast information sharing between a supplier and a manufacturer. The supplier is responsible for acquiring the necessary capacity before receiving an order from the manufacturer who possesses private forecast information for her end product. We address how different contracts affect the supplier’s capacity decision and, hence, the profitability of the supplier and the manufacturer. We fully develop two contracts (and provide explicit formulae) to enable credible forecast information sharing. The first is a nonlinear capacity reservation contract under which the manufacturer agrees to pay a fee to reserve capacity. The second is an advance purchase contract under which the manufacturer is induced to place a firm order before the supplier secures the component capacity used to build the end product. These contracts serve a strategic role in information sharing. The capacity reservation contract enables the supplier to detect the manufacturer’s private forecast information, while the advance purchase contract enables the manufacturer to signal her forecast information. We show that channel coordination is possible even under asymmetric forecast information by combining the advance purchase contract with an appropriate payback agreement. Through our structural and numerical results we also show that the degree of forecast information asymmetry and the risk-adjusted profit margin are two important drivers that determine supply chain efficiency and which contract to adopt.

Key Words: game theory; screening; signaling; coordination; supply contracts; capacity reservation; advance purchase; payback; asymmetric information; forecast
History: Received: February 12, 2003;

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