Contract design when quality is co-created in a supply chain

Abstract This paper investigates contract design by a firm in a supply chain where the quality of the product delivered to consumers is co-created by the quality decisions of the contract designer (platform firm) and the agent (the service provider) whose inputs need to be coordinated. Revenue is a function of the price charged to consumers, the product quality, and a market parameter which may be private information to the service provider. We focus on a contract with payment terms commonly used by large platforms such as Amazon. The platform firm adopts a menu-of-contracts approach to get the service provider to reveal its private information, resulting in optimal quality effort and price decisions that maximize the expected profit of the platform firm. We examine cases where the platform firm should disintermediate the service provider and make and sell the product itself. To study the coordination ability of the proposed contract, we compare the results with those obtained in the case of complete information via various benchmark scenarios.

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