Product quality improvement and free replace warranty sharing contracts

A contract mechanism to coordinate the supply chain's decision of product quality in conjunction with a free replacement warranty is proposed in this paper. Considering a supply chain with one manufacturer and one supplier, three schemes of contracts are examined, namely first best, no FRW cost sharing and with FRW cost sharing. Our conclusions show that FRW cost sharing contracts have the potential to improve coordination within a supply chain (even though full coordination is ruled out). The model built is a starting point for studying a wide range of contracts for procurement of spare parts, and for setting optimal length of warranty periods.