Research Archive

Warranty Cost Sharing in Supply Chains

Fangruo Chen, Lijian Lu, Hanqin Zhang

Publication type: Working paper

Research Archive Topic: Operations, Risk Management


We consider a supply chain where a buyer (manufacturer) sources a component from multiple suppliers. The buyer uses the component to make a product that she sells to end customers. When the component fails in the field, the buyer incurs warranty costs. The focus of the paper is to examine various ways in which the warranty expenses can be shared between the buyer and the suppliers. We consider two sharing rules. One is called the Equal Sharing Rule, whereby the buyer pays for a fixed percentage of the total warranty expenses associated with the component with the rest of the warranty costs equally shared by the suppliers. The other is called the Target Sharing Rule, whereby the buyer still pays for a fixed percentage of the total warranty costs but the rest of the warranty expenses are allocated to the originating suppliers of the defective components. The suppliers can each exert efforts to improve the quality of the component, and improved quality reduces warranty costs. Another benefit to a supplier who exerts qualityimproving effort is gaining a larger market share. Therefore, the suppliers are engaged in a multi-person game by each choosing an effort level that together impacts not only their market shares but also warranty expenses in the supply chain. After characterizing the equilibrium outcomes of the quality-improvement game under both sharing rules, we provide conditions under which the buyer prefers one sharing rule over another. We also show how the comparison between the sharing rules changes if the buyer can set the wholesale price to maximize her own profits. Finally, we compare the performance of the decentralized supply chain with the centralized scenario and provide conditions for supply chain coordination through proper warranty cost sharing and wholesale pricing. Numerical examples are used to illustrate various sensitivity analyses.

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Chen, Fangruo, Lijian Lu, and Hanqin Zhang. "Warranty Cost Sharing in Supply Chains." Working Paper, Columbia Business School, 2012.

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