Contract designing for a supply chain with uncertain information based on confidence level

Abstract We consider a contract-design problem for two competing heterogeneous suppliers working with a common retailer. The retailer's type – low-volume or high-volume – is unknown to the suppliers. One supplier has a high variable cost and a low fixed cost, whereas the other has a low variable cost and a high fixed cost, and their variable costs are uncertain. They sell the same products to the retailer, and each supplier offers the retailer a menu of contracts. The retailer chooses the contract that maximizes her alternative profit based on her confidence level instead of her expected profit. In this setting, we find that the retailer's optimal order quantity is determined by the inverse distribution of the external demand and the confidence level. Furthermore, higher confidence levels correlate with lower order quantities. We also show that the equilibrium contract menus depend on the magnitudes of the confidence level and the high fixed cost. Importantly, if the confidence level of the supply chain tends to be 0 or 1, the supplier with the low fixed cost possesses a competitive advantage over the other supplier. In some cases, the supplier with the low fixed cost may choose not to serve the high-volume retailer to avoid excessive information rent.