This paper presents a supply chain game with a manufacturer and its supplier, where each firm seeks to allocate its own resources between improving design quality and reducing the production cost of a finished product over finite contract duration. The firms agree on a linear contract where the supplier either periodically updates the transfer price, i.e., cost-plus contract (CPC), or sets a definitive transfer price at the beginning of the contract, i.e., wholesale price contract (WPC). Assuming a committed manufacturer, we account for the possibility that the supplier is either committed or non-committed, and derive homogeneous and heterogeneous Nash equilibrium strategies under a CPC and a WPC. We then compare the impact of the supplier’s strategy on the tradeoff between quality and efficiency and the firms’ payoffs, and shed light on the relative merits of a CPC and a WPC. We notably show that a CPC is more robust to the supplier’s strategy type than a WPC in terms of efficiency, quality, and profits. Contrary to the literature, we conclude that a variable transfer price is preferable to a constant transfer price.
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- cost-reducing R&D
- design quality
- linear contracts
- supply chain management