557 / 2024-04-25 22:32:43

Co-sourcing Contract Design with Volatile Demand and Workload-based Control

co-sourcing,volatile demand,workload-based control,contract analysis,pricing

This paper considers a subcontracting contract problem faced by a contractor and a subcontractor. The contractor faces volatile demand and is considering outsourcing part of the demand to a subcontractor. Each demand brings a fixed revenue to the contractor. In the collaboration, an ex-ante transfer price is set by the subcontractor for each demand outsourced. When deciding the transfer price, the subcontractor takes into consideration both the volume of demand and the volatility of demand. If the contractor outsources the demand in a proportion-based way, then the subcontractor’s pricing is analytical, because the volatility of outsourced demand remains the same pattern as the initial demand. In practice, however, the contractor is more likely to outsource the demand in a workload-based way, that is, the contractor outsources more demand when the workload is high and less demand when the workload is low. Consequently, the volatility of outsourced demand becomes more complex and the subcontractor’s pricing is analytically difficult. To handle this problem and obtain managerial insights, we propose an approximation solution by breaking the contractor’s stochastic demand arrival process into a high state and a low state. In each state, we treat the contractor’s outsourcing as a separate proportion-based control policy. Through an extensive numerical study, we establish that our solution is robust. In particular, our policy performs well over a wide range of parameters of practical interests.