Introduction

Literature Review
Objective
Application
Results
Conclusion
References
In many industries, the output quantity of a
production process is not deterministic.
After the production decision is made, there are many
factors influencing the output quantity.

Example:
In agriculture sector: Weather is an important factor
that affects most agriculture related industries, and it
is almost impossible to accurately forecast the future
weather when the planting decisions are made.





In Semiconductor Industries: The quality of the
chips manufactured in very expensive facilities
(fabs) is uncertain due to disturbances such as a
small amount of dust content in the air, a small
timing error in production, etc. Therefore, the same
input might yield different output.

A similar phenomenon can be observed in many
other industries. Therefore, the same input might
result in different output.

So, Random Yield is very common in reality.
Effect of Random Yield on supply chain:

All types of decisions,
1.) pricing decisions
2.) ordering policies
3.) production decisions etc.
are different in the random yield case from those in
deterministic yield case.
Random Yield in one part of the supply chain will
influence the whole supply chain.
It will cause overproduction risk or underproduction
risk.



To determine how random yield influences the
decisions of independent decision makers in the two
level supply chains and how random yield affects
the performance of the two level supply chain.

We will discuss following questions:
1.) In different institutional settings, how is the risk from
yield randomness distributed among the parties in the
supply chain?
2.) How does random yield affect the performance of the
supply chain under these institutional settings?
3.) By studying different contracts, we will try to find

Which contract is better for certain industry?
Which contract makes the supplier better off?
Which contract makes the retailer better off?
What are each partys optimal decisions(pricing,
ordering etc.) under different situations?
What kinds of factors (production cost,
inventory cost etc.) will affect optimal decisions?
Different type of supply chain models considered:
1.) Centralized Supply Chain: the supplier and the retailer are
under control of one company and we find the optimal
production decision for the whole chain.

2.) Decentralized Supply Chain: depending on how the
random yield risk is distributed between the supplier and
the retailer, different type of contracts between the supplier
and retailer are considered.
No risk sharing Contract
Risk sharing Contracts
Underproduction Risk Sharing
Overproduction Risk Sharing
Hybrid Risk Sharing
Centralised Model
Assumptions:
1.) In the centralized model, it is assumed that the retailer and the supplier
belong to the same company.
2.) It is assumed that there is no set up cost for the supplier.
3.) Payment of the wholesale price could be seen as an internal revenue
transfer, which will not influence the supply chain performance.

The expected supply chain profit is expressed as:



Where,
=Expected profit of supply chain
p=Selling price
Q=Order quantity
X=Demand
C=production cost per unit
U=random variable of random yield distribution


The optimal order quantity (Q)is given by equation :



The optimal production decision, Q0, decreases in the costprofit
ratio.

When the ratio is small, the supplier has an incentive to produce
more to prevent underproduction.

Since, the loss of underproduction will be high when the profit
margin is large, or when the cost of production is small as compared
to the potential profit.

Unlike the classic supply chain literature, both the yield randomness
and the demand uncertainty influence the optimal production
decision in our model.

0
( ) ( )
c
uG uQ F u du
p

=
}
No Risk Sharing Model
The retailer orders from the supplier and requires all the ordered
products delivered on time.

The retailer does not share the random yield risk with the
supplier. Retailer faces only the risk from the market uncertainty.

If suppliers yield is below the ordered quantity, we assume that
there is an emergency production source with unit cost c
e
.

Supplier Retailer Demand
q
x
q

Q uQ
Supplier Profit function:


The supplier profit function is concave in Q and Q* satisfy,



Q*(q)=K1 q where, K1 is a function in c, c
e
and f(.).

K1 is increasing in c
e
and decreasing in c and independent of
w(wholesale price).

The higher the emergency cost is, the more the supplier produces; the
higher the production cost is, the less the supplier produces.

Note that we assume that c
e
and w are independent.
( )
s
e u
qw c E q uQ cQ
+
(
H =

/
0
( )
q Q
e
c
uf u du
c
=
}
Since, supplier always delivers q units the retailer faces a
standard newsvendor problem assuming no holding costs
the optimal order quantity satisfies,





If w is not exogenous then, supplier pricing problem
becomes,



| |
min( , )
R x
pE x q wq H =
( *)
p w
G q
p

=
max( ) * ( * *) *
s
e u
w
wq c E q uQ cQ
+
( H =

Underproduction Risk Sharing
URS-1
The retailer orders q, the supplier makes his optimal production
decision Q.

At the end of the period, the supplier ships the minimum of the
ordered quantity and the produced quantity.

Assuming an exogenous wholesale price w, this problem is again
a two-stage decision problem.

The underproduction yield risk is shared between the supplier
and the retailer, while the overproduction risk is carried only by
the supplier.
The supplier profit function is,


The supplier profit function is concave in Q and Q* satisfy,



Q*(q)=K2,1 q where, K2,1 is a function in c, w and f(.).

K2,1 is increasing in w and decreasing in c.

The higher the wholesale price is, the more the supplier
produces; the smaller the production cost is, the more the
supplier produces.


max( ) ( )
s
u
Q
qw wE q uQ cQ
+
(
H =

/
0
( )
q Q
c
uf u du
w
=
}




Knowing the suppliers optimal response, the retailer maximizes
his own profit function.
The actual shipped quantity from the supplier is min{q,uQ}.
So the expected profit of the retailer,


The
R
is concave on q and q* can be solved from:


| | | |
,
min( , ) min( , )
R
u x u
pE x uQ wE q uQ H =
| |
1/
0 1/
min(1, )
( ) ( ) ( ) ( )
k
u
ukq k q
wE uk
ukg x f u dxdu g x f u dxdu
p

+ =
} } } }
Supplier Retailer Demand
q
x
Min(q,uQ)
Q uQ
When the suppliers yield is less than the ordered quantity, it is
assumed that the supplier uses an emergency source to fulfill the
unmet order.
The supplier and the retailer share the emergency production
cost by a certain fraction.
The retailer always get his order, but shares risk of under
production.
For each unit of emergency production, the supplier pays c
e
(1-)
and retailer pays c
e
.
Underproduction Risk Sharing
URS-2
Supplier Retailer Demand
x
q
q
Q uQ
Max(0,q-uQ)@ Ce
The supplier profit function is,


The supplier profit function is concave in Q and Q* satisfy,



Q*(q)=K2,2 q where, K2,2 is a function in c, c
e
, and f(.).

K2,2 is increasing in c
e
and decreasing in c and .

The higher the emergency cost is, the more the supplier
produces; the smaller the production cost is, the more the
supplier produces.


max( ) (1 ) ( )
s
e u
Q
qw c E q uQ cQ |
+
(
H =

/
0
( )
(1 )
q Q
e
c
uf u du
c |
=

}
The retailers profit function is:



The
R
is concave on q and q* can be solved from:



As expected emergency cost shared by retailer increases, his
optimal order quantity decreases.

Depending on how large the fraction of emergency cost is shared
the suppliers optimal quantity deviates from that in centralised
model.
| |
min( , ) ( )
R
x e u
pE x q c E q uQ wq |
+
(
H =

(1 )
( *)
e u
p w c E uk
G q
p
|
+
(


=
When the suppliers yield turns out to be more than the ordered
quantity, the retailer shares the cost incurred by over production.
Constant production costs are assumed and extra units are
bought at discounted price.
The retailer always get his order, if uQ<q then he satisfies
demand from emergency sources.
Retailer buys all units from supplier and pays w
1
for q units and
w
2
for rest of the units.
Over production Risk Sharing (ORS)
Supplier Retailer Demand
x
q at w1
Max(0,uQ-q) at w2
q
Q uQ
Max(0,q-uQ)@ Ce
The supplier profit function is,


The supplier profit function is concave in Q and Q* satisfy,



Q*(q)=K3 q where, K3 is a function in c, c
e
, w
1
, w
2
and f(.).

K3 is increasing in c
e
and decreasing in c.

Given, w
2
<c < w
1
, if w
1
< c then, it would not be optimal for
supplier to produce any .


1 2
max( ) ( ) ( )
s
e u u
Q
qw c E q uQ w E uQ q cQ
+ +
( ( H = +

/
2
1 2 0
( )
q Q
e
c w
uf u du
w c w

=
+
}
The retailers profit function is:



The
R
is concave on q and q* can be solved from



Keeping the whole sale price w
2
small prevents the supplier from
producing excessively large number of units.

The pressure of delivering ordered quantity and overproduction
risk sharing gives supplier incentive to produce more.

{ } { }
1/ 1/
1 1 2
0 1/ 0 1/
( ) ( ) ( ) ( ) ( ) ( 1) ( )
k k
ukq k q k
p ukg x f u dxdu p g x f u dxdu ukw f u du w w uk f u du

+ = + +
} } } } } }
{ }
, 1 2
min , max( , ) ( )
R
u x u
pE x q uQ wq w E uQ q
+
(
H = (


When the suppliers yield turns out to be more than the ordered
quantity, the retailer shares the cost incurred by over production.
Constant production costs are assumed and extra units are
bought at discounted price.
The retailer also shares underproduction risks if, uQ<q and the
supplier does not incur emergency costs.
Retailer buys all units from supplier and pays w
1
for q units and
w
2
for rest of the units.
Hybrid Risk Sharing (ORS)
Supplier Retailer Demand
x
Min(q,uQ) at w1
Max(0,uQ-q) at w2
q
Q uQ
Max(0,q-uQ)@ Ce
The supplier profit function is,


The supplier profit function is concave in Q and Q* satisfy,



Q*(q)=K4 q where, K4 is a function in c, w
1
, w
2
and f(.).

K4 is increasing in w
1
and decreasing in c.

If <c/w
1
then K4 is decreases in w
2
and if c/w
2
then K4
increases in w
2.




1 1 2
max( ) ( ) ( )
s
u u
Q
qw w E q uQ w E uQ q cQ
+ +
( ( H = +

/
2
1 2 0
( )
q Q
c w
uf u du
w w

=

}
The retailers profit function is:



The
R
is concave on q and q* can be solved from




( )
, 1 2
min , ( ) ( )
R
u x u u
pE x uQ wE q q uQ w E uQ q
+ +
( ( H = (

{ } { }
1/
1 1 2
0 0 1/
( ) ( ) ( ) ( 1) ( )
k
k
p ukG ukq f u du ukw f u du w w uk f u du

+ = + +
} } }
Five contracts representing different situations in random
yield risk have been considered:
1.) Centralized supply chain
2.)No-risk sharing contract(NRS)
3.) Underproduction risk sharing
URS-I : Underproduction loss sharing
URS-II : Emergency Cost Sharing
4.)Overproduction risk sharing contracts
5.) Both risk shared by supplier and retailers (UORS)

The application of different contracts depends on the
negotiating power of supply chain parties.

The suppliers production quantity decision usually shows
a linear relation with the retailers order quantity.
Depending on the random yield risk sharing scheme, the
linear coefficients are different in different contracts.

When the supplier shares more random yield risk, the
supplier inputs more for the same ordered quantity.

The retailers order decision depends on both the suppliers
response and the risk sharing plan.

The random yield might help to enhance the whole chain
profit by inducing higher delivered amount from the
supplier.
The models presented here have been solved only for
a two level supply chain, but in reality supply chain can
have different levels. So these models can be solved for
supply chains having more than two levels and a
comparative study of different contracts can be done.

Here the stochastic proportional yield model is used.
However, the input amount Q sometimes plays a role
in yield distribution and could influence yield
distribution. Further study can be done that deals with
a generalized yield in the supply chain.
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