Building a mutually beneficial partnership to ensure backup supply

In today׳s complex global environment, it is very important for a firm to possess backup supply resource when facing unpredictable disruptions from its primary supply resource. To ensure the actual arrival of backup supply in cases of primary supply disruptions, a purchasing firm needs to work with its backup supplier to forge a strong partnership that not only protects itself, but also assures the backup supplier׳s economic benefit. In this research, we establish the structure of such a partnership based on real business practices. The interactions between the purchasing firm and the backup supplier are examined through a decision-tree approach that takes disruption situations at all levels into consideration. We then design the backup supply contract, find the Nash equilibrium contract parameters, and identify the critical conditions under which such a contractual partnership will be valuable. The contract parameters we find are functions of the moments of the demand distribution, which are independent of specific demand distributions and are easy to be estimated in practice. Our numerical tests support our theoretical results and demonstrate the robustness of the contract with respect to various demand distributions.