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Consider a supply chain in which a product must pass through multiple sites located in series before it is finally delivered to outside customers. Incentive problems may arise in this system when decisions are delegated to corresponding site managers, each maximizing his/her own performance metric. From the overall system's point of view, the decentralized supply chain may not be as efficient as the centralized one. In practice, alternative performance mechanisms are often used to align the incentives of the different managers in a supply chain. This paper discusses the cost conservation, incentive compatibility, and informational decentralizability properties of these mechanisms. In particular, for a special type of supply chain, we show that a performance measurement scheme involving transfer pricing, consignment, shortage reimbursement, and an additional backlog penalty at the last downstream site satisfies all these properties.
Lee et al. (Sat,) studied this question.