Hedging demand uncertainty in a two-echelon supply chain: Advanced purchase discount or transshipment or both?

Abstract

Advanced Purchase Discount (APD) and transshipment are two popular strategies to hedge against demand uncertainties in supply chains. However, so far there are no theoretical guidelines on which strategy should be selected under what situations. Moreover, fewer scholars investigate the joint impacts when both strategies are adopted in the same supply chain. This paper examines the interaction between two strategies in a two-echelon supply chain with one manufacturer and two independent retailers. In addition, we design a joint contract, under which the manufacturer signs an advance-purchase discount contract with the two retailers and facilitates the transshipment between them when one faces stock out while the other has a surplus. Our analysis shows that APD and transshipment are complementary to each other to some extent. While the retailers always prefer the joint contract due to its high flexibility, the manufacturer achieves the highest profit if only APD is applied. However, APD itself is not an equilibrium policy unless the manufacturer can prevent the retailers from making transshipment themselves. Otherwise, there exists a zone of Pareto improvements where it is more beneficial for the manufacturer to facilitate transshipment and generate higher profits rather than opting out of it. The zone is based on the retailer’s price margin and the overall supply chain’s margin ratios. Outside the zone, the manufacturer would not participate in transshipment even if it cannot be prevented. This gives another reason, besides its complexity, why the joint contract is not implemented as commonly as APD or transshipment in practice.