Sharing the Risk: Understanding Risk-Sharing Contracts from the Supplier's Perspective

Risk-sharing contracts are known to be an effective means for a supplier to increase channel profit by sharing the risk of supplydemand mismatches with their buyer. This chapter describes an activity for introducing two types of risk-sharing contracts, buyback and revenue sharing, exploring when each is more appropriate to use. The activity consists of two exercises where students take on the role of supplier, first choosing which contract to offer, and second setting contract parameters for one of the contract types. In discussing the outcomes, students discover that the profit margin of a product (whether it is high versus low margin) leads to differences in contract preferences and profit levels. This provides an opportunity to introduce two important behavioral factors, loss aversion and prospective accounting, that help explain these contract performance differences.