Simultaneous coordination of capacity building and price decisions in a decentralized supply chain

In this paper, we investigate the simultaneous coordination of price and capacity building decisions in a dyadic supply chain. This problem is a combination of capacity reservation problem and pricing problem. While the coordination of supply chain with stochastic demand and fixed prices has received much attention in the literature, price-dependent and stochastic demand has been less considered. We study the latter case where a price-setting retailer faces a linear decreasing demand with respect to price. To capture the uncertainty of the demand, we add a stochastic variable to the demand function. In addition, we incorporate production rate and inventory cost on the supplier side. We propose Revenue Sharing Reservation Contract with Penalty (RSRP) as a coordination mechanism to align the price and capacity decisions. We then extend the model to include multiple retailers which are geographically dispersed. We next conduct a comprehensive numerical example with an extensive sensitivity analysis to understand the behavior and robustness of the supply chain under a RSRP, and finally, we draw some managerial implications.