The value of supply chain coordination under moral hazard: A case study of the consumer product supply chain

In this paper, we examine a real-world case related to the consumer product supply chain to analyze the value of supply chain coordination under the condition of moral hazard. Because of the characteristics of a buyback contract scheme employed in the supply chain, the supplier company’s sales department encourages retailers to order more inventory to meet their sales target, whereas retailers pay less attention to their inventory level and leftovers at the end of the season. This condition induces moral hazard problems in the operation of the supply chain, as suppliers suffer from huge returns of leftover inventory. This, in turn, is related to the obsolescence of returned inventory, even with penalty terms in the contract for the return of any leftovers. In this study, we show under the current buyback-based supply chain operation, the inventory levels of both the supplier and retailers exceed customer demand and develop vendor-managed inventory (VMI) system with base stock policy to remove any mismatch of supply and demand. A comparison of both systems shows that through the proper coordination of supply chain operations, both suppliers and retailers can gain additional benefits while providing proper services to end customers.