Question

Pick one type of contract from a supply chain/logistics and defend the use of that option based on the contractual relationship between the two parties of sampled transaction.

Need various reasons as to why you think that contract is the best and if it could be at least one page. Thank you in advance!

Example:Long-Term Contract, Portfolio Contract, Advance Purchase Contract, Pay-Back Contract, Cost-Sharing Contract, Buy-Back Contract, Revenue-Sharing Contract, Quantity-Flexibility Contract, Sales Rebate Contract etc.

Answer 1

Pay-Back contract and modification:

Let's look at the pay-back contract where every unit produced by the manufacturer is agreed on a particular price by the buyer but is not actually bought by the distributor. Now, because of the risk reduction associated with unused capacity the manufacturer is motivated to produce more. But the catch is that here distributor's risk is going to increase. This is because the stock that is produced more has now the risk of being left behind in case the order falls short of the goods produced. However, it is designed in such a way that the increased quantities compensate for the increased risk.

This contract is seemingly the best. To understand better, let's assume the distributor offers to pay $10 for every unit produced but not consumed. If the original cost for 1 unit is $50 and $20 is the raw asset value then the manufacturing loss is now reduced to $50-$20-$10 = $20. So, the manufactures marginal profit will be $30 which is more than the loss. The manufacturer will be motivated to increase production to 1000 or 10,000. With the increase in production, the profit for both manufacturer and distributor will increase compared to the profit otherwise.

This can also be referred to as a variation in a pay-back contract which is the pay-back revenue-sharing contract. In the case when there is an asymmetry in the demand and the yield, then this modified pay-back revenue-sharing can be put in place. It is often believed that both the parties i.e. the supplier and retailer are in a better position in using such terms than under a simple wholesale price contract. This modification also ensures the supply chain system efficiency. That is why a Pay-Back contract is recommended where a distributor or retailer pays a discounted price for their share of the output in excess and shares a part of the profit with the manufacturer or supplier.