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Emerging Research

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Incentive Contracts that Improve Efficiency and Profits of Firms in the Supply Chain

Findings of recent research conducted by Dr. Mark Frascatore, Associate Professor of Economics, and Dr. Farzad Mahmoodi, Professor and Director of the GSCM Program, was published in the European Journal of Operational Research in the first issue of 2008. Their research demonstrates how incentive contracts, designed to increase capacity, ultimately improve efficiency and profits of Original Equipment Manufacturing (OEM) firms and component suppliers within the supply chain.

While there has been a growing body of research undertaken in recent years on a host of methods to correct for OEM underinvestment in capacity, models to date have not demonstrated increased efficiency or profits for either the OEM or the supplier. Frascatore and Mahmoodi's collaborative research includes a modified two-part pricing model in which a contract incorporates variable or per unit OEM investment in increased supplier capacity, with a pre-determined, mutually-agreeable fixed "rebate" paid back to the OEM. The model was tested using fixed financial incentives to the OEM within a negotiable range, and accounted for variable costs of production. In each tested case, the model resulted in increased profits for both firms and overall efficiency in the supply chain.

"This model applies well-known economic concepts in novel ways to improve supply-chain efficiency," says Dr. Frascatore of the research. Frascatore and Mahmoodi are expanding their research to test the effects of this theoretical model on OEM output price, and ultimately sensitivity and impacts on consumer pricing.