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Contracting in Supply Chains: A Laboratory Investigation

Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802
School of Business, University of Kansas, Lawrence, Kansas 66045
ekatok{at}psu.edu
dianawu{at}ku.edu

The coordination of supply chains by means of contracting mechanisms has been extensively explored theoretically but not tested empirically. We investigate the performance of three commonly studied supply chain contracting mechanisms: the wholesale price contract, the buyback contract, and the revenue-sharing contract. The simplified setting we consider utilizes a two-echelon supply chain in which the retailer faces the newsvendor problem, the supplier has no capacity constraints, and delivery occurs instantaneously. We compare the three mechanisms in a laboratory setting using a novel design that fully controls for strategic interactions between the retailer and the supplier. Results indicate that although the buyback and revenue-sharing contracts improve supply chain efficiency relative to the wholesale price contract, the improvement is smaller than the theory predicts. We also find that although the buyback and revenue-sharing contracts are mathematically equivalent, they do not generally result in equivalent supply chain performance.

Key Words: supply chain contracts; experimental economics
History: Received: June 12, 2006; accepted: July 28, 2009.