Discussion paper

DP19013 Supply Chain Frictions

A central problem in supply chains is to coordinate the mismatch between supply and demand along the chain. This paper studies a problem of contracting between a manufacturer and a retailer who privately observes the retail demand materialized after the contracting stage. Under quite general assumptions, we show that the optimal contract must be either a wholesale contract or a buyback contract, depending on the retailer's ex-ante liquidity and bargaining power. In a buyback contract, the manufacturer requests an upfront payment from the retailer and buys back the unsold inventory at a previously agreed price. Depending on downstream liquidity and bargaining power this price may be constant or demand-dependent. Since return shipments are inefficient, retail supply and price will be lower than the first-best level. The optimal contracts are robust to several extensions including multiple retailers.


Chen, Y, Z Gui, E von Thadden and X Zhao (2024), ‘DP19013 Supply Chain Frictions‘, CEPR Discussion Paper No. 19013. CEPR Press, Paris & London. https://cepr.org/publications/dp19013