Robust sourcing contract design for the manufacturer under supply risk

Utilizing incentives to mitigate supply risk has become one of the most important research issues in supply chain management. In this paper, we consider a decentralized supply chain that consists of one manufacturer and one supplier. The manufacturer is ambiguous on the distribution of the supplier’s random production capacity, where the supplier can exert an unobservable effort for capacity improvement and has private information about its effort cost. We introduce uncertain parameters of the capacity distribution within an ellipsoidal uncertainty set. Based on the principal-agent theory, we investigate how the manufacturer designs robust sourcing contracts to incentivize the supplier. Importantly, we obtain a closed-form solution of the optimal robust sourcing contract. We show that, regardless of the information structure, the optimal wholesale price is always increasing in the degree of parameter uncertainty. Under asymmetric information, we find that a bunching contract, rather than a menu of contracts, is optimal. By comparing the manufacturer’s optimal profit under asymmetric information with that under symmetric information, we examine the value of information and how it is influenced by the related factors. We show that the value of information is increasing as the difference in the supplier’s effort costs (or the proportion of a more cost-efficient supplier) increases. Overall, the findings of our paper provide useful guidelines for manufacturers to mitigate supply risk in many practical situations.