Dynamic conformance and design quality in a supply chain: an assessment of contracts’ coordinating power

We consider a two‐echelon supply chain involving one manufacturer and one supplier who collaborate on improving both design and conformance quality. Design quality is supposed to increase product desirability, and therefore market demand, while conformance quality should reduce the proportion of defective items, and therefore increase the manufacturer’s sales revenue. We investigate how the supply chain parties allocate effort between design and conformance quality under both cooperative and non‐cooperative settings in an intertemporal framework. Furthermore, we evaluate wholesale price contracts and revenue‐sharing contracts in terms of their performance and coordination power. We show that although a revenue‐sharing contract enables the manufacturer to effectively involve the supplier in quality improvement, neither contract type allows for perfect coordination resulting in the quality that can be achieved by a cooperative supply chain. We thus suggest a reward‐based extension to the revenue‐sharing contract, to ensure system‐wide optimal quality performance. Importantly, we find that the supplier would be better off adopting a reward‐based revenue sharing contract and refusing a standard revenue‐sharing contract, while the opposite would be true for the manufacturer.