Quantity Flexibility Contract Design in Supply Chain under Adverse Selection

The problem of quantity flexibility contract design is studied in the setting that the downstream retailer's marginal cost is his private information. In a two stage supply chain system which contains a single supplier and a single retailer, the distortion of low cost retailer's order quantity and the impact on profit of the supply chain caused by asymmetric information are analyzed using the analytical framework of contract theory. The tradeoff relation between information rent extraction and efficiency loss is obtained and the second best quantity flexibility contract under adverse selection is designed. The contract increases the supplier's expected profit and the efficiency of the supply chain by reducing the high cost retailer's order quantity and paying information rent to the low cost retailer. The results of numerical analysis confirm the conclusion.