What are the biggest benefits of shared-savings contracts for supplier and buyer in supply chain?

According to Corbett  and DeCroix ,  The potential for improved supply-chain performance through various forms of coordination has been demonstrated extensively in recent literature and management practice. However, there are many materials for which the quantity needed by a firm is at best indirectly related to the quantity of final product produced by that firm, such as solvents in manufacturing processes or office supplies. For any such “indirect” materials, an inescapable incentive conflict exists: The buyer wishes to minimize consumption of these indirect materials, while the supplier’s profits depend on increasing volume. Both buyer and supplier can exert effort to reduce consumption, hence making the overall supply chain more efficient. However, no supplier will voluntarily participate unless contract terms are fundamentally revised. This can be done through a variety of “shared-savings” contracts, where both parties profit from a consumption reduction .

The benefits of shared-saving contracts for supplier and buyer in SC supply chain are:-

First, a key benefit of chemical management services programs to suppliers lies in ensuring continuing business with its customers. In such instances, the supplier exerts effort now, expecting more profits in future. Second, in practice, two types of cost reduction occur: consumption reduction (e.g., by reducing waste or by improving the customers’ process) and unit cost reduction (e.g., through order consolidation or substituting less expensive chemicals for more costly ones). The early cost savings are often achieved by the supplier’s efforts alone and are primarily unit cost reductions, whereas consumption reductions (which require both supplier and customer effort) follow when the relationship has become more mature. A more sophisticated cost and consumption function would be needed to capture these effects. Third, we have presented the most general framework possible here; it would be valuable to identify specific consumption and cost-of-effort functions to obtain more specific guidelines on how to set the contract parameter a. Another extension would be to make the dependence of consumption on effort stochastic. Current work is ongoing in both directions, building on the double moral hazard literature in economics (see, e.g., Kim and Wang).

Bibliography

Charles J. Corbett  and Gregory A. DeCroix  , Shared-Savings Contracts for Indirect Materials in Supply Chains: Channel Profits and Environmental Impacts , Management Science ,  Vol., No.7, July.pp.–

Agree with Ghada Eweda. Very well explained

Well explained Mrs. Ghada Eweda. Thank you.

Fully Agree With Mrs. Ghada Eweda