Analysis of supply chains with quantity based fixed incentives

This paper examines the use of quantity based fixed incentives to coordinate inventory decisions in a decentralized supply chain. We consider a two stage supply chain of autonomous supplier and distributor and prove that the optimal ordering policy for the newsvendor distributor under fixed incentives is an ( s , S ) type policy. We further show that external and internal quantity based incentives can restore channel coordination in single period and channel members can benefit through arbitrary splitting of the resulting additional chain profit. The single period results are extended to multiple periods and the impact of fixed incentives on the distributor’s optimal stocking policy and channel efficiency are examined under three different multi-period supplier strategies. Numerical examples are used to compare the multi-period strategies and to provide additional managerial insights. The results show that contrary to common belief, incentive plans developed and maintained based only on current inventory data perform poorly in long term and that such incentive plans must be periodically updated to enhance their efficiency. Furthermore, we show that high level of incentives designed to push too much inventory downstream of the supply chain can actually reduce the chain’s efficiency.