Contract types

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Contract types

There are many forms of contracts, some of the common contracts are explained below:

 Two-part tariff

In this case the customer pays not only for the purchased goods, but in addition a fixed amount called franchise fee per order. This is intended to compensate the supplier for his fixed setup cost.

 Sales rebate

This contract specifies two prices and a quantity threshold. If the order size is below the threshold, the customer pays the higher price, and if it is above, she pays a lower price for the units above the threshold.

 Quantity discount

Under quantity discount contract, the customer pays a wholesale price depending on the order quantity. This resembles to the sales rebate contract, but there is no threshold defined. The mechanism for specifying the contract can be complex.The contract has been applied in many situations, for example, in an international supply chain with fluctuating exchange rates.

 Capacity options

While advance capacity purchase is popular in the supply chain practice, there are situations where a manufacturer prefers to delay its capacity purchase to have better information about the uncertain demand.

Buyback/return

With these types of contracts the supplier offers that it will buy back the remaining obsolete inventory at a discounted price. This supports the sharing of inventory risk between the partners. A variation of this contract is the backup agreement, where the customer gives a preliminary forecast and then makes an order less or equal to the forecasted quantity. If the order is less, it must also pay a proportional penalty for the remaining obsolete inventory. Buyback agreements are widespread in the newspaper, book, CD and fashion industries.

 Quantity flexibility

In this case the customer gives a preliminary forecast and then it can give fixed order in an interval around the forecast. Such contracts are widespread in several markets, e.g., among the suppliers of the European automotive industry.

Revenue sharing

With revenue sharing the customer pays not only for the purchased goods, but also shares a given percentage of her revenue with the supplier. This contract is successfully used in video cassette rental and movie exhibition fields. It can be proved, that the optimal revenue sharing and buyback contracts are equivalent, i.e., they generate the same profits for the partners.

Options

The option contracts are originated from the product and stock exchange. With an option contract, the customer can give fixed orders in advance, as well as buy rights to purchase more (call option) or return (put option) products later. The options can be bought at a predefined option price and executed at the execution price. This approach is a generalization of some previous contract types.

 VMI contract

This contract can be used when the buyer does not order, only communicates the forecasts and consumes from the inventory filled by the supplier. The VMI contract specifies that not only the consumed goods should be paid, but also the forecast imprecision, i.e., the difference between the estimated and realized demand. In this way, the buyer is inspired to increase the forecast quality, and the risk of market uncertainty is shared between the partners.

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