Revenue Sharing Contracts Under Quality Uncertainty in Remanufacturing

Business users (suppliers) of information technology (IT) equipment often contract with third party remanufacturers (3PRs) for the end-of-use disposition of their used electronic equipment. Our goal in this research is to develop a model to analyze contracts consisting of an upfront payment (t) and a revenue share (r) between a supplier and 3PR, study their impact on disposition decisions, and explore the impact of 3PR risk-aversion and quality uncertainty on optimum contracts. We model a Stackelberg game where the supplier offers risk protection from quality uncertainty to a 3PR. The 3PR faces a convex increasing remanufacturing cost and a sales revenue that is increasing and concave in the volume resold. We show general conditions under which a unique contract exists and can be expressed in closed form. We calibrate our model using a dataset on supplier contracts and equipment conditions provided by a 3PR. Our managerial insights are derived from the data and summarized as follows. First, there is a benefit to suppliers from characterizing the quality of used assets. Therefore, they should consider adjusting contracts to reflect asset quality. Second, suppliers can increase profit by contracting based on quality grade and using a portfolio of contracts. Third, we show that the asset age impacts contract terms, with suppliers with assets at a lower age keeping a higher revenue share and observing a greater fraction of equipment remanufactured. This suggests that suppliers should consider the benefits of disposition contracts when making equipment replacement decisions.