“The Role of Complexity in Supply Chain Contract and Parameter Selection”
by Dr. Özge Tuncel
PhD Singapore University Singapore University of Technology and Design (SUTD) – Industrial Engineering and Operations Management
It has been established in the prior literature that human subjects fail to optimize parameters for two-parameter efficient/coordinating contracts, such as the buyback and revenue-sharing contracts, due to their complexity or cognitive burden. However, they can optimize the inefficient single-parameter wholesale price contract. Therefore, there is a trade-off between using efficient but complex contracts, and using simpler but inefficient contracts. We set out to identify whether the minimum order quantity (MOQ) contract, often used in business-to-business settings, can mitigate the tradeoff by inducing less cognitive burden than other coordinating contracts. We find that (i) subjects perform significantly better with the MOQ contract compared to other coordinating contracts, both in terms of supply chain performance and their own payoff; (ii) the MOQ contract induces lower cognitive burden than other coordinating contracts; (iii) cognitive burden associated with more complex contracts can be reduced with tools that are designed to lessen complexity and with learning; (iv) when given a choice, subjects choose the MOQ contract more frequently over other types of contracts and they favor the MOQ contract even more as they learn more about the contacts.