Improving supply chain performance and managing risk under weather-related demand uncertainty. (English) Zbl 1232.90033

Chen, Frank Youhua; Yano, Candace Arai

Manage. Sci. 56, No. 8, 1380-1397 (2010).

Summary: We consider a manufacturer-retailer supply chain for a seasonal product whose demand is weather sensitive. The retailer orders from the manufacturer (supplier) prior to the selling season and then sells to the market. We examine how a manufacturer can structure a weather-linked rebate to improve his expected profit. The proposed class of rebate contracts offers several advantages over many other contract structures, including no required verification of leftover inventory and/or markdown amounts, and no adverse effect on sales effort by the retailer. We provide a thorough analysis of the manufacturer’s and retailer’s decisions in this context. We show that the weather-linked rebate can take many different forms, and this flexibility allows the supplier to design contracts that are Pareto improving and/or limit his risk in offering the contract and the retailer’s risk in accepting it. For weather rebates with certain characteristics, the manufacturer can fully hedge his risks of offering a weather rebate by paying a risk premium; we show how this can be accomplished. We also show that the basic structural results extend to settings in which the two parties would like to limit their risk.

MSC:

90B05	Inventory, storage, reservoirs
91B30	Risk theory, insurance (MSC2010)
91G20	Derivative securities (option pricing, hedging, etc.)

Keywords:

weather-linked rebate; weather risk; weather derivatives; supply chain coordination