Quantity Flexibility Contract in the Presence of Discount Incentive

We design a new contract, which we refer to as the QFi contract, that combines the quantity flexibility (QF) mechanism and the price‐only discount incentive. Under the QF contract, the buyer does not assume full responsibility for the forecast, yet the supplier guarantees the availability of the forecasted quantity and extra buffer inventory. In contrast, the price‐only discount contract places full inventory burden on the buyer. We show that the proposed QFi contract effectively balances the inventory risk for both the buyer and the supplier considering both the QF and discount mechanisms. We also show that the QFi contract is able to achieve supply chain coordination. More importantly, the QFi contract's coordinating price scheme does not require knowledge of demand distribution. We identify areas where the buyer and supplier may both benefit from implementing the QFi contract as opposed to the extant QF or price‐only (wholesale) discount contractual decisions in a decentralized supply chain. We also specify the conditions under which supply chain coordination can be achieved in a win‐win manner. We conclude with managerial implications and provide directions for future research.