Penalty Enforcement Or Cost Reduction – Which Approach Better Improves Supplier Process Yield?

Retailers have been increasing standards for suppliers in regard to demand-fulfillment performance. To discourage partial deliveries due to unacceptable, defective products, retailers can unilaterally back-charge the supplier a penalty or collaboratively improve the supplier's production process yield and reduce the supplier's quality investment expenditure. In this study, we create an analytical model that compares the retailer's penalty-enforcement and cost-reduction approaches in which the supplier must optimize its production process yield to minimize the total expected cost. The findings indicate that using either approach can induce the supplier to improve process yield. The simulation results show that the cost-reduction approach may require less effort than the penalty-enforcement approach to attain the same level of quality improvement.