Coordination of the supply chain with quality improvement and customer returns

Abstract

Customer returns are a common issue that significantly impacts firms’ profits, regardless of product quality. To address this, firms can implement strategies like the supplier’s quality improvement and the retailer’s return policy. Additionally, contracts such as buy-back agreements can help distribute the costs of returns between the supplier and retailer. This study employs game theory to analyze how these strategies are formed at equilibrium and how they affect supply chain performance. We also explore whether buy-back contracts and other popular contracts, such as revenue-sharing and sales-target contracts, can coordinate these strategies effectively. Our findings reveal that a decentralized structure discourages the supplier’s quality improvement efforts but does not discourage the retailer’s return policy initiative. Coordination requires differentiating buy-back items based on their reasons, such as quality issues, customer preferences, or leftover stock. While returns due to customer preference should be excluded from buy-back contracts, items returned due to quality or leftovers should be included. Furthermore, the sales rebate contract proves effective in achieving coordination, while the revenue-sharing contract does not. Numerical examples indicate that both the revenue-sharing parameter and the buy-back price for returns due to customer preferences negatively impact supply chain profits. However, buy-back prices for quality returns, leftover units, and sales rebates can potentially enhance overall supply chain profitability.