VHS tapes of a French movie are sold at Savmart, a large retailer. The movie tapes are produced and distributed by Gemini studios. It cost the studio $2 to manufacture and distribute a single tape. Savmart sells the tapes to its customers at a retail price of $18.
Gemini offers Savmart a choice between the following two contracts. Assume that demand for tapes are normally distributed with a mean of 2500 and a standard deviation of 300.
Contract 1: Gemini will charge a wholesale price of $7 per tape.
Contract 2: Gemini will charge a wholesale price of $4 per tape but Savmart will transfer 45% of its revenue to Gemini.
(a) What is the supply chain’s first best solution (first best solution is the optimal solution for the centralized supply chain)?
(b) Do either contracts result in supply chain coordination?
(c) Which contract should Savmart pick?
(d) Can you devise a contract such that both Gemini and Savmart are better off than they would be if Contract 1 were implemented?