We consider a supply chain consisting of one supplier selling through one retailer who faces a newsvendor problem. There is a positive probability that the retailer is capable of gaining improved demand information through costly forecasting. The supplier would like to induce the retailer to forecast and share that information. Restricting the retailer's ability to return unsold product would intuitively appear to be a viable way by which to provide the desired incentives. However, it is well known that a generous returns policy increases the supplier's profit. We explore this tension between providing incentives to forecast and capturing channel profits. We examine both price-based returns mechanisms (buy backs) and quantity-based returns mechanisms (quantity flexibility contracts). Thus, a second goal is to compare the relative performance of these two schemes.
We show that under either contract, inducing forecasting retailers to take a different contract from non-forecasting retailers requires restricting returns. The forecaster is charged a lower price than the non-forecaster but has less flexibility in returning product. Using buy backs, the supplier must sacrifice some channel profit to differentiate between forecasting and non-forecasting retailers. With quantity flexibility contracts, reducing channel efficiency is not required to distinguish between the types of retailers. It is consequently some what surprising that buy backs generally result in greater supplier profit than quantity flexibility contracts unless forecasting is very expensive.
Key words: Supply-chain contracting; forecasting; buy backs; quantity flexibility; Bayesian inventory.