Coordination within a Supply Chain with a Profit Sharing Contract

We analyze an equilibrium choice of a product quality within a supply chain consisting of a manufacturer and a supplier. A quality of an intermediate good is private information of the supplier and determines the quality of a final product. The manufacturer holds all bargaining power and proposes a profit sharing contract to the supplier. We show that (i) such the contract may serve as the efficient mechanism of within-chain coordination in special cases and (ii) tougher market competition may lead to a higher profit of both supplier and manufacturer.