In some strategic alliances, a firm shares its manufacturing capacity with another, and the latter shares its distribution capacity with the former. Even though such bidirectional alliances have become more common, they remain challenging to manage because of the frequent disputes over capacity allocation, especially when demand is uncertain. In this paper, we investigate whether there exists a contractual mechanism that can mitigate the extent of these disputes while improving the profits of all participating firms. We consider two types of bidirectional contracts, namely, the ex post transfer payment contract and the ex ante capacity reservation contract. By modeling the capacity allocation and the bidirectional contract design as a noncooperative game between two firms with noncompeting product lines, we show that, relative to a situation with no contract, either contract can improve the alliance’s total profit in equilibrium. In terms of distribution of the total surplus, we find that capacity reservation contracts always make both firms better off, whereas ex post transfer payment contracts may make one firm worse off. Hence, capacity reservation contracts are more likely to be implemented in practice in such bidirectional alliances. This paper was accepted by Gad Allon, operations management.
