Contract Typology as a Research Method in Supply Chain Management

Transcription

1 Contract Typology as a Research Method in Supply Chain Management Alejandra Gomez-Padilla, Jeanne Duvallet, Daniel Llerena 1 Introduction Studied Variables Application Case Conclusion References Summary: In this paper we present the methodology of research that has been the base of our work. The main objective is to study contractual relations; this is the reason why we talk of a contract-oriented research methodology. Through bibliographical research, assistance to workshops and industrial contacts, we identified the basic elements that are the basic issues for understanding and describing a contractual relation. After explaining why we chose these elements, we will describe them as well as their characteristics. We also show how we describe a relation between an upstream and a downstream company. Then we present a mathematical model of this relationship. Keywords: Contract Typology, Supply Chain Management, Economic Model

2 526 A. Gomez-Padilla, J. Duvallet, D. Llerena 1 Introduction 1.1 Context The purpose of the present work is to propose a contract-oriented research methodology in order to analyze a supply chain dyadic relationship. The upstream company is a supplier of products for the downstream one. The downstream company orders a certain quantity of products that will be consumed according to the final market demand. The study of contracts can be tackled from several perspectives. One of these perspectives is the temporality of the decisions concerning the contract. The decisions that companies are meant to take are classified as strategic, tactical and operational. Strategic decisions are those that influence the long term evolution of the company. Regarding a contract, this concerns first of all the decision of establishing a contractual relation or not. Non-exhaustive examples of strategic decisions would be: future buying options, management of transaction-specific investments, cost analysis of transactions, intellectual propriety, reselling licenses, commercial agreements, cooperation dynamics, technological evolution, change rate fluctuation, legal instances and relational exchanges. All this will be defined during the negotiation process. Our attention is not focused on this, but on the elements which articulate the tactical contract decisions. These tactical decisions will influence the operational decisions of the company. When we began our study of contracts, we found it necessary to frame the different situations found to differentiate them and to properly situate our work. We have identified and analyzed the main elements, considered implicitly and explicitly, to be able to model different contractual situations. These elements, which can eventually become modeling variables, are the result of bibliographical research (theoretical and case study oriented literature), seminar and conference assistance as well as discussion with industrial contacts. The elements studied are: 1) time horizon of the analysis; 2) the number of different products exchanged; 3) the information: which information the upstream company shares with the downstream company and vice versa; 4) the characteristics of the demand the downstream company faces; 5) the way financial flows take place, that is, the type of contract to which companies have to adjust their exchanges; 6) the considered costs; 7) the physical flow between the companies, that is, the quantity of products that they are exchanging; 8) the frequency of delivery of these products, or delivery splitting; and 9) the flexibility of quantity delivery in terms of physical flow.

3 Contract Typology Organization of the Document In part 2, the identified elements are analyzed, presenting their definition and the different situations which may be observed. We accord special attention to the financial flows, which are determined by the type of contract and are the main issue and initial purpose of our research. We demonstrate in part 3 how this typology was used as a starting point to describe the context in which our research will proceed. We describe some contracts using the typology developed and explain with three examples the importance of the contract for the performance of the supply chain. We illustrate then how to pass from this description to a model. With this part we explain how the variables are an important background to reference and describe the dyadic relations in a supply chain. We show how this contract typology can serve as a methodology for analyzing supply chains, describing them, and modeling different situations. Finally, in part 4, we present our conclusions and perspectives. 2 Studied Variables 2.1 Time Horizon The time horizon refers to the number of periods considered. We distinguish between two types of time horizons: mono-period and multi-period. When there is only one period, the problem is known as news vendor problem. When there are multiple periods, they can be definite (limited) or indefinite. The time horizon determines how long the decisions taken are going to impact the companies. There is an issue particular to the mono-period situation: It means that there are no stocks, so there are no products remaining from preceding periods, and unsold products cannot be used in the future (though they can eventually be scrapped). This situation has been studied (among others) by Cachon (2004) and Larivière (2002). The multi-period situation can be for a specific number of periods or for an unspecified number. When the number of periods is specified, this is usually in order to accomplish a specific objective. This situation has been studied by authors such as Anupindi & Bassok (2002), and Bassok & Anupindi (1997). When the number of periods is not specified it is known as a steady state situation, such as the one studied by Tsay (1999) among others. In a model, the multi period situation is represented in terms of k periods.

4 528 A. Gomez-Padilla, J. Duvallet, D. Llerena 2.2 Number of Products The number of products refers to the quantity of different products that are to be exchanged between the two companies. We consider as different products those having different characteristics. Contracts can be either mono-product or multiproduct, with the number of products being a source of flexibility in the exchanges when one product can be substituted by another. Usually the approaches are mono-product. An interesting multi-product approach is the one studied by Anupindi & Bassok (2002). Products are modeled as variables whose sum serves to attain a certain objective. 2.3 Information Exchange Information is defined as the available data. There is some information that is known to the upstream company and some to the downstream one. The question is: Which information is to be shared, and/or, which company has to share its relevant information? Two situations can be observed: 1) both companies share their information and, 2) at least one of the companies shares its information. The first situation is said to be symmetric and the second asymmetric. Depending on the available information, each company is going to make decisions, so it would be easy to think that the more information available, the more the decisions made will help to achieve the objectives fixed by the company. Information is a very complex issue to which several authors have oriented their research. Chen (2004) has studied and classified the upstream and the downstream information. Lee & Whang (2000) reviewed the types of information shared. Gallego & Ozer (2002) presented different models of the use of demand information and inventory policies, and Lee et al. (2000) proved that information sharing provides significant inventory reduction and cost savings to the manufacturer. Jacot (1996) has done a review of the importance of information for a company. The information is a situational issue, so it is to be studied on a case-by-case basis. 2.4 Demand The demand is the need for a particular product or component (APICS, 1998). From our bibliographical review, we classified the demand according to its accuracy. Two situations exist: 1) when the demand is deterministic (no uncertainty as to the forecasted demand) and 2) when the demand is stochastic (uncertainty is explicitly considered). Deterministic demand it given as a constant, whereas stochastic demand requires a distribution function to describe it. Demand is a important aspect of supply chain management, so most of the authors touch upon it in one way or another (Corbett & Tang, 2002; Gallego & Ozer, 2002; Weng 1999).

5 Contract Typology Type of Contract A contract is a statement of the rights and obligations of each party to a transaction or transactions (Penguin Dictionary of Economics, 2003), in which the involved parties agree to perform or not perform specific acts or services. It may be oral or written. We center our attention on contracts according to the activated financial flow in terms of price and the reasons for the exchanges. We have identified seven different types of contracts: Wholesale price: The price for each product is fixed previously and will not change. Quantity discount: The price for each product is digressive according to the quantity of products exchanged. Buy back: The downstream company pays a fixed price per unit, but the upstream company must pay a certain quantity for the unsold units. Revenue sharing: The downstream company pays a fixed price per unit and then must give the upstream company a percentage of its revenue, which are the proceeds from the sale of the units to its clients. Quantity flexibility: The downstream company pays a fixed price per unit and, after the sales, the upstream company refunds this price for the minimum quantity between a percentage (fixed by the contract) of the units the downstream company bought and the unsold units. Sales rebate: The downstream company pays a fixed price per unit, but the upstream company offers a rebate for the units bought over a threshold fixed by the contract. Capacity reservation: The downstream company agrees to buy a certain number of units and the upstream company agrees to provide them. If the final order is for a lesser number of units, the downstream company is obliged to pay anyway for the agreed units. If the final order is for more units than agreed upon, the price demanded by the upstream company will also be higher. The prices are fixed depending on the type of contract, and the contract determines the financial flow or transfer between the companies. Some authors who describe different contract modalities are Anupindi & Bassok (2002), Cachon (2004), Harland (1996), Lariviere (2002), Reve (1990) and Tsay (1999). The contracts are represented in a model as a function of the exchanged quantities.

6 530 A. Gomez-Padilla, J. Duvallet, D. Llerena 2.6 Costs The costs are defined as the expenses which the company incurs, other than acquisitions, in order to provide a certain product to a client, including the penalties for not providing the said product. The costs can be described, according to our dyadic case, as the financial flows between the companies or to a third party. In an analysis, we can decide either to not consider any costs at all, or if costs are considered, we must decide which costs ought to be considered. Considered cost may be represented in a model as a parameter or as a function according to the specific situation studied. Some authors who consider costs in their analysis are Cachon & Zipkin (1999), Lariviere (2002) and Tsay (1999). The costs that we have identified are: Stock: The cost of holding inventory. Stockout: The cost of running out of inventory to satisfy the demand. The goodwill cost and the backlog cost, when existent, are also part of this cost. Production: The cost of modifying products or components in order to have a final product in accordance with the specifications of the clients. Salvage: The cost (or gain) for removing, selling, scrapping or any other way of giving use to an unsold product that will not be stocked to be sold in the future. Capacity creation: The cost of reserving resources to produce a certain number of units. 2.7 Quantity Per Order The quantity per order refers to the number of units the downstream company orders. There are three possibilities: 1) Constant: the downstream company orders the same quantity every time it passes an order; 2) Minimal: the downstream company orders a quantity of products to comply with the contract (in terms of physical or financial flow); 3) Unique: the downstream company can order any quantity without constraints. The quantity affects the logistical service in terms of the frequency and splitting of delivery, vehicle routing and capacity, inventory control and production systems. Point 2.9 concerns the flexibility that can exist regarding the agreed quantity. This point, as well as the next two, have been developed, among others, by Anupindi & Bassok (2002), Bassok & Anupindi (1997) and Tsay (1999). The quantity per order is usually modeled as a decision variable.

7 Contract Typology Delivery Splitting Delivery splitting is the division of the committed quantity into groups of deliveries. There are two possibilities for the shipping of units to the downstream company: 1) un-split or 2) split deliveries. In the second case, the number and quantity per delivery should be defined. The number of deliveries can be fixed or not. The delivery quantity may be fixed (the same number of units per delivery) or can be fixed throughout the duration of the contract as long as the downstream company has received the complete order by a certain date. Delivery splitting can be a decision (constant), a result of the quantity per order (variable) or a result of the time horizon (constant or variable according to the case). 2.9 Quantity Flexibility This point refers to how the quantity agreed to in the contract can be modified during the contractual relation. This issue is modeled by establishing boundaries to zero, minimum or maximum quantities, or to infinity. We found three situations: No flexibility: when the agreed upon quantities cannot be modified. Min, Max: when the quantities can be modified as long as they stay within a fixed range of values. The minimum and maximum quantities accepted can be established as a percentage of the quantity originally agreed upon. Min, : when the engaged quantities can be modified as long as they respect a minimal boundary. There is no maximum level because the upstream company has no supply constraints. The elements used to analyze the contractual relations between the two companies according to our contract typology are represented schematically in figure 1. This figure is used to present in short the previously developed elements. 3 Application Case 3.1 News Vendor The news vendor is a well known problem in management science and operations research; we use it here as an example to describe a contractual relation. Consider a person who sells newspapers: This person orders a certain quantity of newspapers from his supplier, the printing company, according to how many newspapers he expects to sell that day. The newspaper distribution department has the possibility to supply as many journals as he requests. He is then confronted with the

8 532 A. Gomez-Padilla, J. Duvallet, D. Llerena decision as to how many newspapers he must order to satisfy demand. If he orders too many, at the end of the day he will be left with unsold newspapers that he won t be able to sell the next day; on the other hand, if he doesn t order enough, he won t be able to satisfy demand and consequently he won t have as much revenue as he could have had if he had ordered more. Contract Typology Time Horizon 1 period N periods Number of Products Mono Multi Information Exchange Symmetrical Asymmetrical Demand Determinist Stochastic Type of Contract Wholesale Price Quantity Discount Buy-back Revenue Sharing Quantity Flexibility Sales Rebate Capacity Reservation Costs Not considered Stock Stockout Production Salvage Capacity Creation Quantity per Order Unique Minimal Constant Delivery Splitting Mono Multi Fixed Not Fixed Quantity Flexibility Inexistent min, Max min, Figure 1: Elements to Consider in the Analysis of Dyadic Contractual Relations Using our research methodology to analyze this situation, we can describe this as a case with a time horizon of one period, exchanging one product, with asymmetric information (the news vendor only knows his own information buying and selling price, while the newspaper company knows, besides this information, its own costs), the newsboy faces a stochastic demand, wholesale price contract, without explicit consideration of the costs, for a unique quantity, where the delivery frequency is constant and with no quantity flexibility. This is shown in figure 2. Since we are mostly interested in the contractual relation, we are going to describe with more attention what happens between the newspaper company and the news vendor if we consider three contracts: wholesale price, buy back and sales rebate. If the contract is one of a wholesale price, then the newspaper company will fix a price, and the news vendor will pay that amount per journal he has ordered. If the demand is higher than his order, he will not have sold as many as he could have, and if the demand is lower, then he will have lost the amount paid per unsold

9 Contract Typology 533 newspaper. This is the situation that we have already described using the identified elements to analyze a supply chain. Contract Typology Time Horizon 1 period N periods Number of Products Mono Multi Information Exchange Symmetrical Asymmetrical Demand Determinist Stochastic Type of Contract Wholesale Price Quantity Discount Buy-back Revenue Sharing Quantity Flexibility Sales Rebate Capacity Reservation Costs Not considered Stock Stockout Production Salvage Capacity Creation Quantity per Order Unique Minimal Constant Delivery Splitting Mono Multi Fixed Not Fixed Quantity Flexibility Inexistent min, Max min, Figure 2: Classic News Vendor Problem Represented According to the Contract Typology Consider now the situation where the buy back contract exists between the two: The newspaper company will be obliged to buy the unsold journals, usually for a lower price than the one at which they were sold to the news vendor, at the end of the day. Under this situation, the news vendor will have an interest in ordering more newspapers than under a wholesale price contract since he is sharing with the newspaper company the loss associated with the unsold newspapers. On the other hand, if the contract were in the form of a sales rebate: The newspaper company offers a certain price for each newspaper up to a certain quantity. If the news vendor buys a number of newspapers that exceed this quantity, the price will be lower for the excess newspapers. In this way, the news vendor is encouraged to buy more newspapers at the discounted price that the newspaper company offers him for buying more, no longer sharing with him the loss for unsold journals. In the three cases we have described, we offer evidence of the fact that, even though the only element that changes is the type of contract, each example of the supply chain would have a different performance. As we said at the beginning of this section, the news vendor model is a classical problem of study in several disciplines. One of the main implications of this model

10 534 A. Gomez-Padilla, J. Duvallet, D. Llerena is that there is no stock. When we move on to a problem were stock exists, we pass automatically to a problem of n-periods. In the next paragraph we will describe an n-periods situation. Suppose that there are two companies, Company A and Company B. Company A produces envelopes and supplies them to Company B, which sells them to its clients. Company B has to order a certain number of boxes each week containing the envelopes, depending on its demand forecast. The boxes ordered are to be delivered once per week, and Company A can supply all the boxes ordered by Company B. When there are boxes that were not sold during one week, they will be stocked to be sold for the next week. The fact of stocking implies some expenses for Company B. Companies A and B know the production costs of A, the conditions of the contract between them, the price over the final market, the stocking cost and the demand forecast. B pays A a fixed amount per box. Using our research methodology to analyze this situation, we recognize that the problem is one in which the time horizon is of n-periods, with the exchange of one product, with symmetric information, facing stochastic demand, using a wholesale price contract, with consideration of stock and production costs, for a unique and different quantity per period, where the delivery frequency is constant with no quantity flexibility. We show in figure 3 the representation of this situation. In our work we found it useful to use this method of description to classify and analyze the relations between companies. After typifying a contractual relation between two companies which are members of a supply chain, we found it necessary to create a model so that we could represent some of the elements. This will permit us to measure the performance, in our case in economic terms, since it is this aspect of the relation which interests us. 3.2 Model The purpose of our model is to measure the performance of two companies by calculating the profit for each member of the supply chain. In this section we explain how each element from section 2 can be represented. To do so, we will present how the profit of the members of the chain is modeled. Consider then the situation presented in the last paragraphs at point 3.1 and shown in figure 3: Company A supplying a product to Company B. We consider an n-period situation, with Company B facing a demand characterized by an identical F distribution function and f density function in each period. We are in a steady state situation, so we don t need to differentiate each k period. All instances are independent of the period. The quantity of boxes that Company B has to order is q, in order to satisfy a base stock. We define Q as the boxes that Company B has available at the beginning of each period (base stock); this is, the ordered boxes q, plus the boxes in stock. The decision variable for Company B is Q, so its sales and its stock are expressed as functions of this available quantity. The expected sales and stock are

11 Contract Typology 535 represented by S(Q) and I(Q) respectively. The expected financial flow between the companies or transfer for supplying the ordered boxes to Company B is T(q). The market price of each box is P, the cost for Company B of holding in stock one box is h and the cost for Company A of producing one box is c. The expected benefit for Company B is equal to the expected revenue made by the sold boxes minus the cost of the expected inventory it has to hold for the next period minus the expected financial transfer to Company A for the ordered boxes. The expected benefit for Company A is equal to the expected financial transfer minus the cost for Company A of producing the q boxes ordered by Company B at the k period. Contract Typology Time Horizon 1 period N periods Number of Products Mono Multi Information Exchange Symmetrical Asymmetrical Demand Determinist Stochastic Type of Contract Wholesale Price Quantity Discount Buy-back Revenue Sharing Quantity Flexibility Sales Rebate Capacity Reservation Costs Not considered Stock Stockout Production Salvage Capacity Creation Quantity per Order Unique Minimal Constant Delivery Splitting Mono Multi Fixed Not Fixed Quantity Flexibility Inexistent min, Max min, Figure 3: Case Example represented According to the Contract Typology If we define B (Q) as the expected benefit of B (distributor), A (Q) as the expected benefit of A (supplier) in any period, we can represent them as: B (Q) = P S(Q) h I(Q) T(q) (1) A (Q) = T(q) c q (2) The financial flow of each company depends on the contract. In a wholesale contract, the expected transfer is T(q)= w q, the wholesale price w at which each box

12 536 A. Gomez-Padilla, J. Duvallet, D. Llerena is sold to Company B times the quantity of boxes ordered for that period. The benefit of the companies is then: B (Q) = P S(Q) h I(Q) w q (3) A (Q) = w q c q (4) We have so far shown how to consider most of the elements shown in 2: time horizon, number of products, demand, type of contract, costs and quantity. There are three elements not yet discussed in this model: information exchange, delivery frequency and quantity flexibility. The information exchange is mostly a strategic issue. If either of the companies has information concerning the other, they can apply pressure, mostly through changes in the price w, so that the other company takes certain actions that will be more convenient. The delivery frequency and the quantity flexibility are restrictive elements, adjusted if needed as constraints. 4 Conclusion We have presented here a research methodology consisting of framing the contract-oriented research. In this work we identified the elements to be considered, the forms they can take, and their importance. We showed how these elements can be the basis for modeling different situations. This contract typology-based method of analysis can be useful in terms of global comprehension of the supply chain. It can first of all be used to make a general description of the situation and the conditions of work in dyadic relations. It allows the comprehension of the mechanisms that represent the frame of their exchanges. Secondly, it can also be useful as a basis for modeling different contractual situations. It can help to understand the influence in the model of each identified element. This typology can also help to distinguish elements that may become variables and that have an important role in terms of the economic objective. This research method can also serve as a guideline to identify in which of the analyzed issues a more in-depth survey is necessary. The future trends of research for the present paper are basically three: survey, simulation and case study. A survey directed towards companies in order to analyze their contractual practices will help to understand when and why certain decisions are taken. The survey should be ideally done for several industrial sectors. Another trend will be to pursue the study by simulation, after modeling the situations in which the analysis must be deepened; this will imply the use of empirical data. Finally, continuing with a case study, it will be possible to have a complete picture of a particular situation. An interesting case study would be for the electronics sector and the retailing industry. These two types of business are found to be relevant for this approach.

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