Coordination of Ordering and Production Policies in A Two-Level Newsvendor Model Under Quantity Flexibility Contract

In this paper, a two-stage newsvendor model with one type of product in presence of stochastic demand under quantity flexibility (QF) contract is investigated. Under the proposed model, the manufacturer allows the retailer to update its order size upward or downward. Under this mechanism, the manufacturer is committed to provide a certain level more than the retailer’s primary order to deliver when large demand is observed; in addition, the retailer has the authority to cancel a limited amount of its initial order in the beginning of selling season when the observed demand is small. Under these circumstances, overstocking/shortage risks are shared between two members. By sharing risks, it will be possible to optimize decisions globally. In this paper, a new approach for optimal adjustment of QF parameters (i.e. upward and downward adjustment parameters) is developed. Expected profit functions of both channel members under QF contract is mathematically modeled and optimal closed-form relationship between upward and downward adjustment parameters is determined. The obtained closed-form relation guarantees more profit for the whole supply chain and at the same time assures more profit for both channel members. Under the proposed model, both members benefit from the coordinated decision making while risk of demand uncertainty is shared. Our investigations revealed that increasing flexibility on cancelling initial order causes less flexibility of the manufacturer in providing more products. On the other hand, decrease of cancelling flexibility results in more flexibility for oversupply volume.