CIS reading notes
Moral hazard: The passage discusses the evolving landscape of supply chains due to
companies focusing on core competencies and outsourcing non-critical processes. It
highlights the complexities arising from global distribution and independent ownership structures, leading to reliance on contracts to align participants' goals. However, incentive conflicts may arise despite well-designed contracts. The example of Blockbuster's revenue-sharing contract with movie studios illustrates initial benefits followed by conflicts due to moral hazard issues. The paper presents a case study on buyback contracts, showing how they can lead to coordination problems and excess inventory. It reviews literature on supply chain coordination, emphasizing the importance of addressing incentive conflicts and information asymmetry. Various contract mechanisms are discussed, with a focus on mitigating moral hazard. Overall, the paper underscores the need for integrated systems and well-designed contracts to coordinate supply chains effectively, especially when dealing with issues like moral hazard.
The case study examines a supplier struggling to compete in the South Korean market, characterized by high competition, demand uncertainty, and a large number of product SKUs. To alleviate retailers' burden of maintaining large inventories, some suppliers adopt buyback contracts, allowing retailers to return unsold inventory. Initially promising, these contracts can lead to moral hazard issues, as retailers become less diligent in forecasting demand and managing inventory. Sales departments may encourage inflated orders to boost sales metrics, despite the risk of excess inventory returns. This behavior ultimately benefits suppliers in the short term but may not translate to increased sales to final customers.
The case study highlights the impact of a buyback contract on a supplier's inventory
management in the context of introducing new products to the market. With the introduction of new products, retailers tend to return unsold inventory under the buyback contract, leading to a significant increase in the supplier's inventory levels.
However, this excess inventory primarily consists of low-demand products, indicating a mismatch between supply and demand. The buyback contract incentivizes retailers to overorder, contributing to the accumulation of excess inventory that the supplier struggles to sell. Moreover, the lack of control over retailers' inventory management exacerbates the issue, particularly with small retailers who lack inventory management practices. Despite challenging market conditions and limited growth opportunities, the supplier aims for aggressive sales targets, potentially leading to moral hazard issues stemming from the pressure to meet revenue goals. To address these challenges, the paper explores the implementation of a vendor-managed inventory system with a base stock level as a solution to reduce excess inventory and mitigate moral hazard.
