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370 SUPPLYCHAINMANAGEMENTimpediments stemming from human nature and tech-
nological limitations. On the other hand, in addition to
“bull-whip” remedies, mechanisms do exist to promote
coordination within the supply chain, and these are de-
scribed next.Incentive Impediments
Lee and Whang (1999) discuss incentive problems that
prevent coordination in a supply chain with a decen-
tralized decision structure. In this type of system, each
site manager makes decisions to optimize his or her per-
sonal benefit. This type of incentive misalignment can ex-
ist within and between functional areas of a site (firm)
and also between sites (firms) in the supply chain. For in-
stance, a marketing manager’s objective may be revenue
maximization, and he or she may attempt to generate sales
with trade promotions to induce forward buying. Mean-
while, a manufacturing manager may have a conflicting
objective, such as minimizing production variability or
level utilization. As illustrated through the bull-whip ef-
fect, trade promotions generally increase variability in
production.
These types of conflicts of interest can be addressed
by corporate operating guidelines or rules. For instance,
manufacturing representatives should be evaluated over
a rolling horizon on average sales of their products by
their customers instead of to their customers. This per-
formance measurement scheme removes the incentive to
foster forward buying and reduces cycle inventories. Al-
though, this type of approach works well for allaying con-
flicts within a firm, to mitigate incentive misalignment be-
tween firms, contractual relationships are formed. From a
supply chain perspective, two obvious conflicts of interest
exist between upstream managers and retail managers.
The upstream managers covet end demand information
that retailers own and which, in isolation, they have no
incentive to share. Likewise, if retailers are the only site
managers penalized for stock-outs, upstream sites have
no incentive to carry safety stock even though they typi-
cally incur lower inventory carrying costs than retailers.
To reconcile conflicting interests, channel members resort
to manipulating performance requirements embedded in
contractual agreements.Fostering Trust between Partners
Contractual agreements can also be used to develop a
foundation of trust between trading partners. A simple
contractual relationship is far from a collaborative rela-
tionship, however. Firms’ inability to collaborate has often
been blamed on technological limitations of information
management. Interestingly, Gallagher (2001) commented
that during a spring 2001 Supply Chain Council executive
retreat, that attendees cited a “lack of trusted relationships
between key supply chain participants” as the main obsta-
cle to effective collaboration. Information sharing is no
longer constrained by information technologies; it is held
back by the impersonal nature of automation. Collabora-
tion, especially information sharing, is limited by shallow
business relationships. It is for this reason that collabora-
tive supply chains seek to identify channel members thatadd significant value and develop richer relationships with
those firms. Higher levels of trust can be achieved through
elaborate and exhaustive contingency contracts or by in-
teracting over time in a consistent mutually beneficial
manner. These relationships can be sustained if both par-
ties are mutually interdependent and gain mutual benefit
from the partnership. Whether the investment in strate-
gic alliances is justified will depend largely on the supply
chain’s strategy.Incentives from Terms of Sale
Supply chain coordination can be accomplished through
a quantity discount schedule for commodity type prod-
ucts. Because prices for these products are set by the mar-
ket, a lot size quantity discount scheme can coordinate
the supply chain. This holds as long as the increased cycle
inventory costs are less than the benefits of the quantity
discount scheme. This mechanism is well suited for sup-
ply chains with an efficiency driven strategy associated
with commodities. A related approach for incentivizing
suppliers is to enter into long-term blanket orders with
multiple order releases within the planning horizon.
If a seller has market power through a patent, copy-
right, and so on, channel coordination can be achieved
through volume-based quantity discounts. The key differ-
ence between this scheme and the lot size quantity dis-
count is that the volume-based discount is based on the
rate of purchase instead of the amount purchased per or-
der. An example of a volume-based quantity discount is a
two-part tariff. With this arrangement, the seller charges
an initial fee to cover his profit, and then unit prices are
set to cover production costs.
Another way sellers can induce buyers to purchase
greater quantities is to have a returns policy. In offer-
ing a buyback contract, a seller stipulates a wholesale
price per unit as well as a buyback price. The optimal
order quantity for the buyer then rises as a result of a
guaranteed salvage value for unsold products. In situa-
tions in which the costs of returns are high relative to the
salvage value of the product, sellers may coordinate the
supply chain through quantity flexibility contracts. This
arrangement allows buyers to modify their order quan-
tity after observing their respective demand. Rather than
committing in advance of observing demand to a spe-
cific order quantity, the buyer commits to a minimum
order quantity, and the seller commits to providing a max-
imum quantity. Total supply chain profits can increase as
a result of this contractual agreement. By manipulating
the terms of sale, sellers can induce buyers to purchase
in greater quantities, which ensures sellers greater prof-
itability. What is somewhat surprising is that buyers, too,
can gain increased profits if these terms of sale are appro-
priately set.
Supply chain coordination can be achieved if incen-
tives are aligned throughout the supply chain via contracts
or consistent performance measures, information passes
accurately through the supply chain, operations perform
optimally, and the requisite level of trust exists within
the supply chain. It is therefore understandable that un-
til recently, achieving channel coordination or optimiz-
ing total supply chain performance seemed impossible.