Improving Supply Chain Performance and Managing Risk Under Weather-Related Demand Uncertainty

  • Authors:

  • Frank Youhua Chen;Candace Arai Yano

  • Affiliations:

  • Department of System Engineering and Engineering Management, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong;Haas School of Business and Industrial Engineering and Operations Research Department, University of California, Berkeley, Berkeley, California 94720

  • Venue:
  • Management Science
  • Year:
  • 2010

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Abstract

We consider a manufacturer-retailer supply chain for a seasonal product whose demand is weather sensitive. The retailer orders from the manufacturer (supplier) prior to the selling season and then sells to the market. We examine how a manufacturer can structure a weather-linked rebate to improve his expected profit. The proposed class of rebate contracts offers several advantages over many other contract structures, including no required verification of leftover inventory and/or markdown amounts, and no adverse effect on sales effort by the retailer. We provide a thorough analysis of the manufacturer's and retailer's decisions in this context. We show that the weather-linked rebate can take many different forms, and this flexibility allows the supplier to design contracts that are Pareto improving and/or limit his risk in offering the contract and the retailer's risk in accepting it. For weather rebates with certain characteristics, the manufacturer can fully hedge his risks of offering a weather rebate by paying a risk premium; we show how this can be accomplished. We also show that the basic structural results extend to settings in which the two parties would like to limit their risk.