A model of incentive contracts for just-in-time delivery

A mathematical model is used to analyze how to structure on-time delivery incentives in a contract between a buyer and a single supplier of raw materials when early shipments are forbidden. The buyer's choice of incentives takes the supplier's cost-minimizing response to incentives into account. The least cost incentive a buyer can select is specified by a probability of on-time delivery and an incentive scheme to achieve that probability. These optimal solutions are characterized without specifying the flow time distribution. A method of selecting incentives that can help buyers improve on-time delivery performance is provided; however, the limitations of incentives are also considered. Achieving exactly 100% on-time delivery is shown to be non-optimal and only feasible under specific conditions. When management can not specify the shortage cost, their selection of a desired probability of on-time delivery allows for the determination of an imputed shortage cost.