The Research of Supply Chain Contract under the

Uncertainty of Demand Based on Inventory

Management
Yifan Xu
School of Management
Huazhong Uni. of Science &Technology
Wuhan, Hubei Province, 430074,China
[email protected]
AbstractThis paper mainly researched the coordinate problem
about the supply chain contract under the uncertainty of demand
based on inventory management, and discussed the necessary
condition of achieving coordination of supply chain system under
the uncertainty of demand and the specific impact that the
corresponding contracts have brought. The paper constructed
the profit model of vendors of supply chain contract under the
uncertainty of demand, and used the reverse reasoning method of
dynamic planning to study the profit model. The research
findings indicated that the supply chain contract under the
uncertainty of demand based on inventory management will help
to achieve the Pareto optimization and can realize the best overall
performance and the perfect coordination of the supply chain
system under the uncertainty of demand.
Keywords- contrac; supply chain; uncertainty

I.

INTRODUCTION

Supply chain coordination under the uncertainty of demand

is the focus of the theory field and the practice of business.
The various activities between the manufacturers and vendors
must consider that the actual needs of users may be uncertain.
We can roughly divide it into two stages: The first stage is the
normal sales stage, the products of manufacturers are facing
less competition on the market, manufacturers produce the
products and sell them to vendors with wholesale price, and
vendors add a certain amount of profit for selling to
customers; The second stage is the stage of selling with
decreasing price, since they are more and more competitors in
the market, and products gradually moving towards maturity
and even recession period from the growing period,
manufacturers decided to use the price decreasing strategy to
enhance the competitiveness of their products and to obtain
more benefits. But this strategy will damage the interests of
vendors in a certain extent, because customer demand that the
vendors faced is uncertain, they take on some additional risk,
and they must require some compensation. Hence
manufacturers need to provide a certain amount of
compensation to vendors according to price decrease of the
unsold products, and the unsold products must be repurchased
in the end of the Sales cycle. This strategy is also used in

Zhang Yong
School of Management
Jinan University
Guangzhou, 510632, China
[email protected]
commercial practice frequently, but there were few literatures
analyzed its modeling. Donohue studied how to design the
contract of return price on the supply chain coordination and
Pareto optimality [1], but not consider the cost of returning
products. Lee, Wang constructed the two-phase sales model
[2-3], but only use the repurchase of price compensation
strategy at a certain stage, the condition of realizing the system
coordination is not only depends on the cost structure of
system, but also demand distribution. Pasternack analyzed the
repurchase contract under the flexible orders [4], and pointed
that the effective wholesale prices and return price of goods
can improve coordination efficient through Pareto
optimization. Its limitation is that when the repurchase price is
too high, this approach will be ineffective. Eppons study
showed that the contract which contained the supplementary
agreement can improve the benefits of both sides [5], but the
contract have no supplementary agreement has difficulty to
achieve this goal. Tsay studied the applicable conditions of
return strategy and unsalable subsidy strategy under the
traditional model (vendors orders only once, manufacturers are
also produce one time) [6]. Taylor analyzed the two-phase
model for price protection [7]. This study is similar to
Pasternacks. But Taylor's analysis focused on the dynamic
price protection strategy when products on the market are
facing the outdated price risk in the multi-stage. These
literatures seldom discussed the necessary actual conditions
about realizing the coordination of supply chain, the
assumptions of model have some discrepancy with reality, and
therefore it played a limited role in practice. This paper
referred to Lee, Wang and other scholars ideas. It constructed
a theoretical model and conduct a detailed analysis on the
detailed analysis on the supply chain contract under the
uncertainty of demand based on inventory management, and
discussed the necessary condition of achieving coordination of
supply chain system under the uncertainty of demand based on
inventory management and the specific impact that the
corresponding contracts have brought.

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II.

THE ASSUMPTION AND MEANING OF SYMBOLIC

The model of supply chain contract under the uncertainty

of demand has the following assumptions:
(1) Manufacturers produce a single kind of product, and its
unit production costs is unchanged;
(2) Manufacturers are the makers and implementers of the
price discount policy, they have greater advantages than
vendors on the information of price, cost and demand.
(3) The relationship between manufacturers and vendors
can be divided into two phases, the first is normal sales phase,
and the second is the price-decreasing sales phase;
(4) It should be considered the cost of OOS (out of stock)
of manufacturers and vendors.
(5) Users demand are uncertainty, the customers demand
has the price elasticity;
(6) At the end of the first phase, manufacturers decide to
cut down the wholesale price of products, and give some
compensation to vendors about the unsold products;
(7) At the end of the second phase, manufacturers will
callback a certain percentage of the unsold products in
accordance with the inventory in the early stage of the second
phase;
(8) Vendors used EOQ order strategies.
The meanings of symbolics are as follows:
p1 p 2 market price of the first/second phase, they
are constant and p 2 < p1
Q the order batch of vendor, it is continuous nonnegative random variable;
x1 x 2 the demand quantity of consumers for the
first/second phases;
f1 ( x1 ) f 2 ( x 2 ) the probability density function of
the consumers demand for the first and second phases;
F1 ( x1 ) F2 ( x 2 ) the cumulative distribution
function of the consumers demand for the first/second phases,
continuously differentiable;

F0 ( x) =

Q x1

f 1 ( x1 ) f 2 ( x 2 )dx 2 dx1

the

probability distribution function of the total orders for the first

and second phases, continuously differentiable, and strictly
monotone increasing;
cthe production cost of unit product;
m1 m2 The credibility loss cost of manufacturers/
vendors because of the shortage for the first/second phases;
v the unit net residuals of unsold products in the end
of the second phase;
the price increasing extant based on production cost
of manufacturers, > 0
w the wholesales price of the product that
manufacturers produced, w = c (1 + )

Q0 the sales volume of inventory products at the

beginning of the second phase, the non-negative continuous
random variable;
t1 At the end of the first phase of the manufacturer's
decision to lower product prices, the compensation for the unit
price of products that the manufacturers gave to vendors;
t 2 the unit repurchase price of the vendors unsold
products at the end of the second phase;
1 At the end of the first phase of implementation of
price compensation strategy, the proportion of the price
compensation quantity over the order amount at the beginning
of the first stage;
2 At the end of the second phase when the
manufacturers implementing the repurchase strategy, the
proportion that the repurchase quantity over the inventory
quantity of vendors at the beginning of the second phase;
S1 (Q ) M 1 (Q) the expect profit of vendors/
manufacturers during the first phase, in the case of order batch
Q;
T 1 (Q) the expect profit of vendors and
manufacturers during the first phase, in the case of order batch
Q;
S 2 (Q ) M 2 (Q ) the expect profit of vendors/
manufacturers during the second phase, in the case of order
batch Q;
In the above symbols, v < c < w < p1 , that is, the
product residual<production cost<wholesales price<the
market sales price of the first phase. Because the price is
decreasing at the second phase, then p 2 < p1 ;
Due to the sale of products in the first stage is in the growth
period of the product life cycle, the market demand is large
and high-value products. The losses will even greater if the
shortage is coming. So we have c 2 < c1 , m2 < m1 ;
Manufacturers and sellers are rational, to ensure that the
manufacturer's price subsidies strategy are acceptable for
vendors, and vendors make the greatest efforts to sell products
in the first stage, the rational choice for vendors is to accept
the price subsidies at the end of the first phase, so we have
p1 + c1 > p 2 + t1 , w > t1 + c1 , w < t1 + p 2 ;
To ensure that the manufacturer's repurchase strategy can
be accepted by vendors and vendors make the greatest efforts
to sell products in the first stage, the rational choice for
vendors is to accept repurchase at the end of the second phase,
therefore we have t1 > t 2 + c 2 , p 2 + c 2 + m 2 > v ,

p2 c2 > t 2 , t 2 c2 > v .

c1 c 2 the unit inventory expense of the unsold

product in the first/second phases;

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III.

THE OVERALL PROFIT MODEL OF SUPPLY CHAIN

CONTRACT UNDER THE UNCERTAINTY OF DEMAND

Because price subsidies and repurchase are among the

manufacturers and vendors, and will not affect the overall
supply chain profits based on inventory management, thus, the
key elements in the supply chain overall profit based on the
inventory management under the uncertainty of demand are
included ( p1 , p 2 , w) .
Assuming vendors have Q0 inventory products at the
beginning of the second phase, to describe the problem
expediently, we use the reverse reasoning method of dynamic
planning to study the overall profit model of supply chain
contract under uncertainty of demand. During the second
phase, users expect demand to abide by the following rules:

x 2 < Q0

x2
x2 =
Q0

(1) When x 2 < Q0 , the overall profits of the supply chain

during the second phase consists of three parts: sales
revenues; the residual income of the unsold products at the
end of the second phase. It equals the unit residual price v of
the unsold product multiplied by the amount of the unsold
products (Q0 x 2 ) ; inventory costs.
2When x 2 < Q0 , the overall profits of the supply
chain during the second phase consists of two parts: sales
revenues; The loss of shortage.
So the overall expected profit of supply chain contract
during the second phase is:
Q0

2 (Q0 ) = [ p 2 x 2 + v (Q0 x 2 )
0

(1)

c 2 (Q0 x 2 )] f 2 ( x 2 )dx2 +

Q0

[ p 2 Q0 m2 ( x 2 Q0 )] f 2 ( x 2 )dx2

At the first stage, the expected demand quantity of users

obeys the following rules:

x1
x1 =
Q

1 (Q ) = c Q +

[ p1 x1 + 2 (Q x1 ) c1 (Q x1 )] f1 ( x1 )dx1 +

x1 < Q

[ p1 Q + 2 (0) m1 ( x1 Q)] f1 ( x1 )dx1

Because

1 (Q) = c Q +

x 2 Q0

In addition, the overall profit for the supply chain based on

inventory management in the first phase also includes
production costs, it is equivalent to the unit cost of product
multiplying the consumer demand Q of the first phase.
Therefore, the overall expected profit of supply chain
contract during the first phase is:

[ p1 x1 + 2 (Q x1 ) c1 (Q x1 )] f1 ( x1 )dx1 + 2

[ p1 Q + 2 (0) m1 ( x1 Q)] f1 ( x1 )dx1

2 (0) =

( m2 x 2 ) f 2 ( x 2 )dx 2

Put the above result into (2), we get

1 (Q) = ( p1 + m1 c) Q
+

m1 [ x1 f1 ( x1 )dx1 + Q f1 ( x1 )dx1 ]
0

m2 [

Q x1

x 2 f 2 ( x 2 )dx 2 +

Q x1

x 2 f 2 ( x 2 )dx 2 ]

(3)

(c1 + p1 p 2 + m1 m2 ) (Q x1 ) f 1 ( x1 )dx1
0

( p 2 + m2 + c 2 v)
Q

Q x1

(Q x1 x 2 ) f 2 ( x 2 ) f1 ( x1 )dx 2 dx1

Get the Partial derivatives to (3), and

2 1 (Q )
<0
Q 2

Therefore, the overall profit of supply chain based on

*

inventory management has the max value. Q must satisfy

(m2 m1 + p 2 p1 c1 ) F1 (Q * ) + ( p1 + m1 c)

x1 Q

1When x1 < Q , the overall profits of the supply chain

based on inventory management during the first phase consists
of three parts: sales revenues; the expected profit of the
second phase, because of the inventory quantity of vendors is
(Q x1 ) at the beginning of the second phase, it equals

= ( p 2 v + c 2 + m2 )

Q*

Q * x1

f1 ( x1 ) f 2 ( x 2 )dx 2 dx1

4
Thus, the max value of overall expected profit of supply
chain based on inventory management is:

2 (Q0 x1 ) ; inventory costs.

2When x1 Q , the overall profits of the supply chain
based on inventory management during the first phase consists
of three parts: sales revenues; The loss of shortage; the
expected profit of the second phase, because of inventory
quantity of vendors is 0 at the end of the first stage, then it
equals 2 ( 0) , and 2 ( 0) 0 .

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1 (Q* ) = ( p1 + m1 c) Q*
Q*

m1 [ x1 f1 ( x1 )dx1 + * Q* f1 ( x1 )dx1 ]
m2 [

Q x1

x2 f 2 ( x2 )dx2 + *

Q x1

x2 f 2 ( x2 )dx2 ]

Q*

(c1 + p1 p2 + m1 m2 ) (Q* x1 ) f1 ( x1 )dx1

0

( p2 + m2 + c2 v)
*

Q x1

S1 (Q) = w Q +

Q(1 1 )

[ p1 x1 + t1 1 Q

+ S 2 (Q x1 ) c1 (Q x1 )] f1 ( x1 ) dx1

(Q* x1 x2 ) f 2 ( x2 ) f1 ( x1 )dx2 dx1

5

IV.

inventory quantity is 0 at the end of the first stage, it is equals

S 2 (0) , and S 2 (0) 0 .
In addition, the overall profit for the supply chain based on
inventory management in the first phase also includes
Purchase costs, it is equivalent to the unit cost of product
multiplying the consumer demand Q of the first phase.
Therefore, the vendors expected profit in the supply chain
contract at the second phase is:

THE PROFIT MODEL OF VENDORS UNDER THE

UNCERTAINTY OF DEMAND

Because of the price subsidies and the repurchase are

among the manufacturers and vendors, there are a lot of key
factors in supply chain based on inventory management under
the uncertainty of demand that influenced the vendors, which
mainly including ( p1 , p 2 , w, t1 , t 2 , 1 , 2 ) , and the
influencing factors are different in different stages.
Assume that vendors have Q0 inventory at the beginning of
the second phase, and also use the reverse reasoning method
of dynamic planning to study the vendors profit model in
supply chain contract under the uncertainty of demand. At the
end of the second phase, manufacturers repurchase the unsold
products at the ratio 2 , such acts will impact the vendors
profit.
At the second stage, the expected demand quantity of users
obeys the following rules:

x 2 Q0 (1 2 )
x2

x2 = x2
Q0 (1 2 ) < x 2 < Q0
Q
x 2 Q0
0
(1) When x 2 Q0 (1 2 ) , the vendors profits during
the second phase consists of four parts: sales revenues;
the repurchase revenue that the manufacturers implement the
repurchase; inventory costs; the residual revenue of the
unsold products at the end of the second phase.
(2)When Q0 (1 2 ) < x 2 < Q0 , the vendors profits
during the second phase consists of three parts: sales
revenues; the repurchase revenue that the manufacturers
implement the repurchase; inventory costs;
(3)When x 2 Q0 , the vendors profits during the second
phase consists of two parts: sales revenues; the loss of
shortage. the expected profit of the second phase, since the

Q (1 1 )

[ p1 x1 + t1 (Q x1 ) + S 2 (Q x1 )

(7)

c1 (Q x1 )] f1 ( x1 )dx1
+

+ [ p1 Q + S 2 (0) m1 ( x1 Q)] f1 ( x1 )dx1

Q

Because

S 2 (Q x1 ) =

( Q x1 )

( Q x1 ) (1 2 )

[ p 2 x 2 + t 2 (Q x1 x 2 )

c 2 (Q x1 x 2 )] f 2 ( x 2 )dx 2
+

( Q x1 ) (1 2 )

{ p 2 x 2 + 2 t 2 (Q x1 )

+ v [(Q x1 ) (1 2 ) x 2 ]
c 2 (Q x1 x 2 )] f 2 ( x 2 )dx 2
+

Q x1

[ p 2 (Q x1 ) m 2 ( x 2 Q + x1 )] f 2 ( x 2 )dx 2

S 2 ( 0) =

( m2 x 2 ) f 2 ( x 2 )dx 2

Put the above result into (7), we get

S1 (Q) = ( p1 + m1 w) Q
+ t1

Q (1 1 )

+ (t 2 v )

[ x1 Q (1 1 )] f1 ( x1 ) dx1

( Q x1 )(1 2 )

[ x2

(Q x1 ) (1 2 )] f1 ( x1 ) f 2 ( x 2 ) dx 2 dx1
+ (c 2 + p 2 + m 2 t 2 )

Q x1

( x 2 Q + x1 ) f1 ( x1 ) f 2 ( x 2 )dx 2 dx1

+ ( p1 p 2 + m1 m2 + c1 t1 )
Q

( x1 Q ) f1 ( x1 )dx1
0

We get the Partial derivatives to (8), and according to the

assumption and symbols relationship before, we know that

2 S1 (Q )
<0
Q 2
Therefore the vendors profit has the max value. Let

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V.

S1 (Q)
=0
Q
Q * satisfy
(m1 m 2 + p1 p 2 + c1 t1 ) F1 (Q * )
+ t1 F1 (Q * (1 1 ))
+ ( p 2 t 2 + c 2 + m 2 ) F0 (Q * )

= ( p1 + m1 w)
+ (v t 2 ) F0 (Q * (1 2 ))
Thus, the max value of vendors expected profit is:

S1 (Q * ) = ( p1 + m1 w) Q *
+ t1

Q * (1 1 )

+ (t 2 v )

[ x1 Q * (1 1 )] f 1 ( x1 )dx1

Q*

( Q * x1 )(1 2 )

[ x2

This paper mainly researched the coordinate problem about

the supply chain contract under the uncertainty of demand
based on inventory management, and discussed the necessary
condition of achieving coordination of supply chain system
under the uncertainty of demand based on inventory
management and the specific impact that the corresponding
contracts have brought. The paper constructed the profit model
of vendors of supply chain contract under the uncertainty of
demand based on inventory management, analysed the key
factors that impact vendors in supply chain based on inventory
management under the uncertainty of demand, and used the
reverse reasoning method of dynamic planning to study the
profit model. The research findings indicated that the supply
chain contract under the uncertainty of demand based on
inventory management will help to achieve the Pareto
optimisation and can realize the best overall performance and
the perfect coordination of the supply chain system under the
uncertainty of demand.

(Q * x1 ) (1 2 )] f 1 ( x1 ) f 2 ( x 2 )dx 2 dx1

REFERENCES

+ (c 2 + p 2 + m 2 t 2 )

Q*

Q * x1

CONCLUSION

( x 2 Q + x1 ) f1 ( x1 ) f 2 ( x 2 )dx 2 dx1

+ ( p1 p 2 + m1 m2 + c1 t1 )
Q*

( x1 Q * ) f 1 ( x1 )dx1
0

10
2

S1 (Q )
< 0 , we can see the volume of order Q
Q 2
to maximize S 1 (Q ) is unique. Thus, the order quantity that
Since

maximizes the vendors profit in the supply chain must be the

order quantity that let the overall profit maximization in
supply chain. Only under such condition, vendors can achieve
the maximum profit as well as the best overall performance of
the supply chain.
This shows that it is helpful to achieve the Pareto
optimization and can realize the best overall performance and
the perfect coordination of the supply chain system under the
uncertainty of demand.
If the order quantity of vendors maximum profit in the
supply chain is inconsistent with the order quantity of the
maximum overall profit, vendors may pursue their own
interests in order to maximize their profit and damage the
overall interests of the supply chain, at this time,
manufacturers should adjust the two parameters of compensate
price t1 of the unit product and the unit repurchase price t 2 of
the unsold products, and change the optimal order quantity of
vendors, guiding vendors to maximize profits from their own
economic order quantity to the best economic order quantity
of overall supply chain.

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