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

• Published in: Management science Vol. 56; no. 8; pp. 1380 - 1397
• Main Authors: Chen, Frank Youhua, Yano, Candace Arai
• Format: Journal Article
• Language: English
• Published: Hanover, MD INFORMS 01.08.2010; Institute for Operations Research and the Management Sciences
• Series: Management Science
• Subjects: Applied sciences; Business orders; Demand; Exact sciences and technology; Financial risk; Inventory control, production control. Distribution; Logistics; Management; Management science; Operational research and scientific management; Operational research. Management science; Order quantity; Retail stores; Risk; Risk management; Risk premiums; Sales rebates; Studies; Suppliers; supply chain coordination; Supply chain management; Supply chains; Temperature; U.S.A; Uncertainty; Weather; weather derivatives; weather risk; weather-linked rebate; United States; United States > US; Coordination; Pareto optimum; weather derivatives; Rebate; supply chain coordination; weather-linked rebate; Flexibility; weather risk; Weather; Production management; Perishable item; Sales; Supply demand balance; Retailers; Seasonal demand; Risk factor; Profit; Supplier; Contract; Logistics
• ISSN: 0025-1909; 1526-5501
• DOI: 10.1287/mnsc.1100.1194

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.