 Hello and welcome back to the example that we were looking at which was the probabilistic setting of demand for the news vendor and the impact of the same on the potential payoffs for the news vendor. As we had seen in the previous lecture, the best opportunity for the news vendor actually lies in ordering 40,000 units from the supplier. So far so good we have seen what happens to the news vendor. Now as we have seen in the deterministic setting, here also we need to see what is the impact of this decentralized decision making which is the news vendor taking up decisions based upon his or her profitability and what is the impact of the same on the supplier as well as the supply chain. So, let us look at the suppliers payoffs first. So, on the supplier side in a similar way I have shown over here what are the different kinds of costs as well as revenue opportunities for the supplier. The supplier is going to incur a fixed cost of 150,000 rupees for manufacturing the newspapers which have to be sold to the news vendor. So, this is going to be irrespective of the batch size. Remember this is a one time decision making problem which means there is not going to be any further opportunities for recovery of any cost as well. So, whatever is going to be the impact that we observe we analyze in this particular time period only. And for the supplier there are also certain manufacturing and operating costs since this is newspapers we call this as printing cost that would be more appropriate and the associated operating cost. We have seen that the operating cost for the supplier is 5 rupees per unit. So, if 10,000 units were to be printed because the news vendor ordered 10,000 units then the total operating cost would be 50,000 rupees. And then we can figure out what are going to be the potential revenues for the supplier. The supplier as we know sells the newspaper at a wholesale price of 10 rupees per unit to the news vendor and so the potential revenues would be 1 lakh. The profit would thus be the revenues less the various costs which is the cost of facility and the cost of operation which turns out to be a negative 1 lakh rupees which means it is not making profits the supplier. So, this would actually not be a preferable position for the supplier. Let us look at other potential order sizes which are going to be present. For each of these cases a fixed cost of 1,50,000 would be incurred by the supplier and the operating cost would increase because of larger lot sizes. So, this would become 50,000 this would be 1 lakh and so on and so forth. A maximum of 2,50,000 given that the maximum that the news vendor is willing to order is 50,000 units. If that is the case we can also see what would be the potential revenues. So, at the very minimum we are obtaining 1 lakh from the news vendor and at the very maximum we are obtaining 5 lakhs from the news vendor. If you were to look at the profits associated with this we will observe that the news vendors decisions have a terrible impact on the supplier if the order sizes turn out to be 10,000, 20,000 or 30,000 units. Luckily for the supplier that is not the case the news vendor is actually ordering 40,000 units for which the opportunity that the supplier has is 50,000 rupees. However, something interesting we can note over here in this case the supplier would actually prefer to manufacture more produce more because in the case of the supplier the profits are simply just increasing as the order size increases. So, once the supplier has gone beyond the break even point of 30,000 units the supplier would like to print as much as possible. But we can observe that that is not the case which happens. What is the case which happens is 50,000 rupees of potential profits is what the supplier has to live with because 40,000 units has been chosen as a order size by the news vendor. Now, let us further understand what is the impact on the total supply chain. For the total supply chain what we are simply going to do is find out what will be the potential profits by adding the expected value of profit for the news vendor and the potential profit of the supplier. And in this case we can see it is 0 minus 1 lakh plus 1 lakh and as we extend the potential profits to the various order sizes we observe that the highest potential profit is obtained at 50,000 units which is 2,60,000. But again this is not achieved because the news vendor is going to be ordering 40,000 units only which results in the overall profitability of 2,50,000. So, there are two opportunities which are lost. One is an opportunity for the supplier who wanted 50,000 units to be ordered. As well as the supply chain who would also have wanted that the order size placed with the news vendor was 50,000 units and not 40,000 units. However, irrespective of the same the good thing is we can see that even in the best decision taken by the news vendor the supplier and the supply chain are overall profitable. So, this leads to the assessment of the potential conflict. The conflict being that both the supplier as well as the entire supply chain would rather be producing an order size of 50,000 units rather than an order size of 40,000 units. But is it possible for the news vendor to order 50,000 units? As we can very clearly see here with 50,000 units the news vendors potential payoffs are only going to be 160,000 which is if you can observe over here worse than even ordering 30,000 units. So, in fact given a choice and if really forced to do the news vendor will probably make an order of 30,000 units rather than 50,000 units and as a result there is very low incentive for the news vendor to order more. So, this is the conflict that we observe. Now, let us go back to our slides. So, we have seen considering the expected value of payoffs the potential order size chosen by the news vendor would be 40,000 units, but we can observe over here that is not the preferred area for the supplier as well as the entire supply chain. So, the best decision taken by the news vendor is not the preferred choice for the supplier and the supplier is actually constrained to produce whatever the news vendor orders. Since, the news vendor initiates the order and the news vendor has no incentive to produce more order more than that and hence this is the decision that is going to be taken for the entire supply chain. So, the better decision would be 50,000 units, but the news vendor has no incentive to even considering this opportunity because the loss that is going to be present by ordering 50,000 units is total of 40,000 rupees expected value of that loss would be 40,000 rupees. So, the news vendor is not going to pick that up. We can also see that the news vendors decision is not the best decision for the entire supply chain. So, the supply chain is also forced to deal with an order size of 40,000 units. The news vendors best decision which has been taken up is a decentralized decision because it is the best decision for that entity, but it impacts the entire supply chain. The supply chain's best decision would have been a centralized decision, but that is not going to be taken up by the news vendor which leads us to a few questions. Namely, can we make the supply chain function at the level of this global best solution which is the 50,000 units? Can we really do this? If so, how? And that way to carry this out is through contracts. So, contracts provide this mechanism in order to allow players to deal with each other and achieve the global best performance of the supply chain such that both the players or all the players, in the case of an entire supply chain, we have multiple players, they can be collaborating with each other in order to produce the best performance not only for themselves, but also for the entire supply chain. And when we look at the role of contracts, we can see that it is basically a formal agreement between the parties where certain terms and conditions are going to be mutually agreed upon and these conditions could be what will be the price that you are going to sell at, what would be the order quantities, what will be the ordering schedule, when are you going to place the order, when are you going to receive the orders, what will be the various payment terms and conditions, what will be the credit period, what would be the duration of the contract itself and it can extend to any kind of parameters that are crucial to that particular business transaction. An effective contract would eventually see to that all the players in the supply chain move to a better off position, an effective contract would enable the supply chain players to move towards a better off position for all the players within the supply chain such that the entities benefit more from where they are currently if this contract was not present. So, if we were to consider this particular scenario in our case, there are variety of contracts that can actually be discussed and implemented, some of them are revenue sharing contracts in which the revenue earned by the news vendor can be shared with the supplier, a portion of it in exchange for a discount on the wholesale price, a buyback contract where the news vendor is going to be incentivized to order more with the promise that if there is any excess stock, the supplier is actually going to purchase it back. In both these cases, we can observe when the contract is put into force, the news vendor ends up sharing information about the market as well as risk with the supplier. Quantity flexibility contract over here is slightly different from buyback contract. In quantity flexibility contract, the news vendor has to return some portion of the excess stock to some extent only, not the entire portion at an agreed upon price. In a quantity discount contract, the supplier will actually incentivize news vendors to order larger quantities by keeping lower unit prices for larger quantities. In our case, we can see that the wholesale price is the same irrespective of the order size that is placed by the news vendor which is 10 rupees per unit, but quantity discount contract, the supplier can actually give discounts for larger order sizes. Let us say for 50,000 units, the supplier will choose to provide a wholesale price of maybe 8 rupees per unit and for the rest of the order sizes, the wholesale price can be decided to be at 10 rupees per unit. A sales rebate contract is one in which we incentivize the news vendor to sell more by giving a reward for selling excess above a certain threshold. One over here, this will encourage the retailers to give discounts on the prices and they will share demand information and risk to the supplier as a result. Other contracts which are not applicable in the scenario that we are discussing, what can still be explored are cost sharing contracts in which the vendor shares information about their cost with the buyer in order to share the cost and as a result of this larger order sizes can be manufactured or produced by the vendor. Similarly, in a payback contract, the vendor might have to produce large lot sizes, but they get unsold at the end of the selling period and in order to compensate for that, the buyer might actually offer to purchase that excess stock which is unsold by the vendor. So, this is the kind of a contract in which it is the supplier has more information about market and costs as opposed to the current scenario that we are seeing. So, let us explore a revenue sharing contract in the context of our example. So, for that let us go to the discussion over here where what have I plotted? First, we look at the news vendor and again we start to the news vendor and instead of looking at the potential sales carried out at the end of the news vendor, we look at the revenues. So, the very concept of revenue sharing as I have mentioned is that the news vendor is going to offer a share of their revenues to the supplier and in exchange the supplier is going to give a discount on the wholesale price. So, these are the two terms that are going to be present in the contract. One is the percentage of revenue share that the news vendor offers and the wholesale price discount that the supplier is going to provide to the news vendor. So, here we have the revenue which is generated. In the market the price of the product is 30 rupees per unit, when the demand is 10000 and the news vendor has purchased 10000, the revenues that are going to be present in the market are going to be 3 lakhs. This is going to exist across the various demand scenarios, when the order size increases for the news vendor, but the demand is just 10000 rupees, again the revenues will just be 3 lakhs and this is going to be the case over here as well. But let us say the news vendor has ordered 20000 units and sells 20000 units, the revenues are going to be 30 rupees per unit into 20000 units, which you can see here is 6 lakhs and naturally as we can observe this is also the maximum that can get sold across all these demand scenarios. So, when we project all of these opportunities across various combinations of demand and order sizes, we can see that the minimum revenues that we can obtain is 3 lakh rupees and the maximum that can be obtained is 15 lakh rupees. So, these are the potential revenues which are possible or the exhaustive set of revenues that are possible and we want to give a portion of this revenues as a news vendor to the supply. So, which means if I were to look at the potential profits for the news vendor, obviously there will be a portion of the profit calculation which considers what was the demand and what was the order size and what was the overall profit from that. However, remember a portion of the revenues are also going to go to the supplier. So, whatever profits are going to be earned, a portion of the revenue side is going to go to the supplier. So, that portion is going to get deducted over here, so that is the last part of that equation. So, let me show you with an example on the revenue share. So, this is the possible revenue share and the wholesale price that can be charged by the supplier to the news vendor and the revenue share that can be offered to the supplier. So, let us say the revenue shared offered by the news vendor to the supplier is 10 percent. So, which means a 10 percent of that 3 lakhs is actually given to the supplier, so that would be 10 percent of 3 lakhs which is going to go to the supplier and the remainder is going to be with the news vendor. So, what does the news vendor actually get? The news vendor is earning a total revenue of 3 lakhs, but from that 3 lakhs 10 percent is going to go to the supplier and there is also a cost associated with distribution of 10,000 units and there is a cost associated with the purchase of those 10,000 units which is going to effectively give rise to 70,000 rupees as the net profit of the news vendor. And when we go down, we can see that 10 percent of 3 lakhs has been given to the supplier. So, this is the suppliers revenue share that is going to be present only for this particular scenario. So, let us say we consider all possible scenarios over here, in all the cases the expected profit for the news vendor is 70,000 rupees and the expected value of revenue that the supplier is going to get is 30,000 rupees. Now, if I were to extend this to the entire domain over here for all possibilities that we have, we can see that this is going to be the profitability matrix for the news vendor. This is different from what we have here. We can observe over here, earlier the news vendor was getting 1 lakh rupees, but now the news vendor is going to get 70,000 rupees because the remainder has gone to the supplier. And earlier the maximum that we were getting was 5 lakh rupees, but with this revenue share the maximum that the news vendor gets is 3,50,000 rupees and the remainder is going to the supplier. Let us look at what is the impact on the decision. The impact on the decision is instead of ordering higher, the news vendor actually orders 30,000 units and remember this is not a decision that is useful for the supplier and we can actually verify this as well. So, for that let us go down and we will observe that the fixed cost of facility is going to be 150,000, the potential manufacturing costs are going to be the same as before, the potential revenues are also going to be the same as before as seen in this case without the contracts, but we are also going to get revenue share which is an additional income for the supplier. And as a result we can observe that the supplier is now going to earn 73,500 rupees as the net profit. Let us see what was the profit before without any contract, we can see that the profit without any contract earlier was 50,000 rupees. And now it has actually gone up to 73,500 rupees, so this is actually good for the supplier, but the question is will my news vendor actually chooses. The news vendors revenues without any contract of revenue share was as you can see over here 2 lakh rupees, this was the expected value of profits and now the expected value of profits for the news vendor is 1,16,500. The news vendor has no incentive to choose this particular contract and hence is the reason why the news vendor would say to the supplier that I am offering your revenue share, I want you to give me a discount on the wholesale price, so that I am incentivized to order more. So for that purpose let us see what is going to be the impact of providing a discount on the wholesale price. So as we can see here let us say we provided a discount from 10 rupees we went down to let us say 9 rupees we can observe over here the news vendors profit actually becomes worse it is not necessarily the best and hence let us say that we give a more heavy discount and we see that it is slowly improving to 1,90,000 and so let us incentivize this further by providing a discount to 7 rupees and we can observe over here that by providing this discount with a revenue share of 10 percent the news vendor is actually going to earn a better profit or expected value of profit of 2,30,000 but it is going to order the same value which is 40,000 units. Is this going to be now acceptable for the supplier is the question. For the supplier we can observe that the overall profits are actually going to come down to 20,000 rupees. The best profit that was obtained was 73,500 with just a 10 percent revenue share but now with a wholesale price discount as well we are observing that the value of this profit has come down to 20,000 rupees which is less than the value of the profit that the supplier could expect without any contract in place which is the comparison that we have over here without any contract in place the value of profit for the supplier was 50,000 rupees without any contract in place the value of profit for the news vendor was 2,00,000 rupees with this contract of 10 percent revenue share and 7 rupees wholesale price we are seeing that the news vendor is doing better but not the supplier with just the revenue share of 10 percent but no discount on the wholesale price we can see that the supplier is doing better but not the news vendor. So, what would be the appropriate value for the revenue share and the wholesale price. So, let us say we make the wholesale price a little less let us make it 6 percent 6 rupees. In this case the news vendor keeps improving in terms of the value associated with the total profit but not the supplier the supplier is actually going into a loss. So, what can we do over here? So, we were looking at what should be the values of revenue share and the wholesale price such that the news vendor as well as the supplier actually going to do better off with that particular decision. So, for that purpose let us also look at what is happening to the supply chains profit. So, when we consider the supply chains profit we can see that when the order value placed by the news vendor is 10,000 the supply chain is at a no loss no profit scenario and as we go to higher lot sizes we can see that the best decision was taken at 40,000 units earning a profit of 250,000 and earning a better profitability perspective profitability of 260,000 if the order size was 50,000 but this is when there was no contract. Now, let us say we were to actually explore a contract which is going to enable the players to do well then this current scenario then we would want that the news vendors expected profit has to at least be 2 lakh rupees or increase further and for the supplier the actual profit for the supplier should also increase further rather than stay at 50,000 rupees and as a result of which if the news vendors expected profit also increases and the suppliers profit also increases then naturally the total supply chains profit will also increase and the increase that we desire would be 260,000 because that is the maximum that we could achieve. So, what are the values that are possible over here? Now, this particular problem can actually be designed as an optimization problem where we want to maximize the total supply chains profit and obtain the revenue share and wholesale price combination that gives us the best value. This is something that I am going to show in a manual fashion as there are going to be many possible combinations that can actually maximize the supply chains profit such that the news vendor as well as the supplier are both going to be better off. So, we had already seen what happens when there was a 10 percent revenue share and the wholesale price was 10 rupees the total supply chain profit would fall down to 190,000 that is not good and suppose we also had a discount of let us say 8 rupees total supply chain profit is going to 250,000 which is not bad, but it is not an improvement and if we gave a further discount 6 rupees the total supply chain profit remains 250,000 it is not getting better. If I made it 5 rupees then the total supply chains profit is actually improving, but at the same time we have to see to that both the players are also doing well. So, in this case I can see that the news vendor is not doing too well is doing better, but the supplier is actually doing worse. So, perhaps the news vendor needs to provide a better profit or revenue share. So, let us say the profit share or the revenue share provided by this vendor is 30 percent. The supplier is going to be doing better, but not the news vendor. So, let us say the news vendor gives a discount and makes it 4 rupees we can see that there is a small improvement in the news vendors expected profit than before if we go down further we can see that the news vendor now does better, but not the supplier. So, somewhere around this region there is a possibility that one is getting crossed over to a better opportunity and the other is getting crossed over to a worse opportunity. Somewhere in between lies a good combination of revenue share and wholesale price that is beneficial to both. So, for the sake of this explanation let us look at a revenue share of 32 percent and let me bring down the wholesale price a bit so that the news vendor is actually also going to do better. We can see that the news vendor is very close to 2 lakh rupees. So, let us make this 2.9 and we can see this is becoming slightly better for the news vendor. And now we can see at this particular revenue share and wholesale price combination the news vendor is also profitable as compared to before before the total profit was 2 lakhs. Now, the total expected profit for the news vendor is 2 lakh 3200 and improvement of 3200 rupees. And for the supplier the total profit is actually 6800 rupees more than before. So, which is definitely better off position for both of them and we can observe that as a result even the total supply chain profit has moved to the highest level which is 2 lakh 60,000. And something very interesting we can observe is that this occurs at the highest value of the order size. So, with this we see that there is a very good opportunity for creating the kind of combinations of the terms and conditions such that both players are going to be better off. And as we see over here in each of these cases let us say in the first case where there was no revenue share and no discount 40,000 units was being ordered by the news vendor. This was not preferred by the supplier as well as the supply chain, but they could do nothing about it. And then we see that when a revenue share is brought in let us say a 10 percent revenue share the news vendor is actually going to go to a worse off position of 116,500 which is not really beneficial for the news vendor. Similarly for the supplier this would actually be a better off position, but the news vendor would not select this position. For the supply chain this would be a worse off position because without a contract the benefit obtained was 250,000 and now it is going to be 190,000. Now when we make the revenue share of 32 percent and let us say a wholesale price of around 2.75 rupees per unit we can observe that the news vendor is ordering the largest size possible in the set of options available and as a result not only does the news vendor do better, but also the entire supply chain as well as the supplier. So, this is that particular comparison that we see that when there is no contract over here and when there are these contracts which are present what is going to happen, we can see that when the revenue share is 0 percent and there is a wholesale price discount only given supplier does not do better. When there is a revenue share, but no discount given on the wholesale price the news vendor does not do better and in fact orders less. When the revenue share is brought in as well as a wholesale price discount is given we can see that the news vendor is doing better, but not the supplier and the supply chain is also not doing better than before, but in a unique combination of 32 percent revenue share and wholesale price of 2.75 rupees we can see that all the players including the supply chain are better off. We can also observe that it is not just this value which is going to give us better off position, but there are many such terms and conditions that could be possible such that both the news vendor and supplier do better than before. What does this actually lead to as an understanding we can see that an effective contract can actually be designed such that both players are going to be better off and this brings the two players to the centralized position of 260,000 rupees of total profit for the entire supply chain. Now, in summary what we see is that the decentralized decisions on their own would give local benefits to the entities, but not to the entire supply chain. While the centralized decisions give benefits to the total supply chain, but not necessarily to the individual entities, but by enabling contracts we can create a scenario where information visibility, inventory visibility, risk sharing and cost visibility is enabled and this provides an opportunity for the various entities to accept these terms and conditions and take decentralized decisions which match with the best possible opportunity for the entire supply chain. Now, we have to think whether the supply chain entity wants to be part of the business or not. So, what the supply chain entity could do is through such kind of analysis decide whether this is actually going to work out in the long run for them and basis that they can choose to be part of that agreement or not. Now, let us try to connect this to the context of platform economy that we were discussing before we move to the next series of lectures where we look at different types of channel structures in the context of the platform economy. In the same way in the context of the platform economy also we would be having such kinds of trade-offs that we would need to look at. For example, should the products be hosted on and sold on a platform or should the seller sell these products directly to the customer or use both these opportunities? What are the trade-offs associated between these options? Should let us say a taxi driver subscribe to a cab aggregation service or directly contact the customers or do both? Should a consumer of digital content such as movies, videos, songs, etc. be provided free content or should they pay for it? Now, in the same kind of perspective that we have seen till now if we were to enable these kinds of scenarios then we need to look at possibilities where the various parties can actually come together and agree upon certain terms and conditions. So, in the same way we can use information visibility inventory visibility risk sharing and cost visibility to be used as levers for designing the appropriate kind of service in the platform economy and such that this is going to be part of the supply chains functioning as well. Now, how we are going to do this? We are going to pick up a few examples in the context of the platform economy that are very relevant for supply chain digitization and we shall explore some of the possibilities of coordination and some very popular business models that are occurring nowadays in the platform economy context. With this discussion, I hope to have explained to you or given you a brief idea of what is the nature of the different types of channel structures namely the decentralized and centralized channel structures and how we can effectively use contracts to enable coordination in the supply chain such that entities within the supply chain want to be part of the supply chain and are actually going to be functioning better than before either if they were not part of the supply chain or if they were part of a supply chain, but not very incentivized to be in that particular position. Then we try to map this idea on to the concepts of platform economy as well in the next few series of lectures. So, thank you everyone and see you in the next class.