Supply Chain Coordination with Revenue-Sharing Contracts: Strengths and Limitations

With a revenue-sharing contract a retailer pays a supplier a wholesale price for each unit purchased plus a percentage of the revenue the retailer generates. This contract form has become more prevelant in the video cassette rental industry relative to the more conventional wholesale price contract. This paper studies the application of revenue-sharing contracts to a general supply chain model. We demonstrate that revenue-sharing contracts maximize the supply chain's profit (i.e., coordinate the supply chain) in a number of settings, including a supply chain with a single retailer and price-dependent revenue as well as a supply chain with multiple, competing retailers. In addition, we show that a variation on the revenue-sharing contract coordinates a single retailer supply chain with effort-dependent revenue. We compare the revenue-sharing contract to several other contracts that enhance channel coordination, e.g., buy-back contracts, quantity-flexibility contracts and sales-rebate contracts. None of these contracts matches revenue sharing's ability to coordinate a wide range of supply chains. We quantify when a revenue-sharing contract provides significant incremental improvement over the simpler wholesale price contract. Finally, we identify several limitations of revenue-sharing contracts to (at least partially) explain why they are not prevalent in all industries.