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European Journal of Operational Research 171 (2006) 516-535
L

ELSEVIER

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Production, Manufacturing and Logistics

A bargaining model with asymmetric information

for a single supplier-single buyer problem
Eric Sucky *
Department of Supply Chain Management, School of Business and Economics, Goethe-University Frankfurt,
Mertonstr. 17, 60054 Frankfurt, Germany
Received 7 December 2001; accepted 23 August 2004
Available online 30 October 2004

Abstract

Banerjees joint economic lot size (JELS) model represents one approach to minimizing the joint total relevant cost of a
buyer and a supplier by using a joint optimal order and production policy. The implementation of a jointly optimal policy
requires coordination and cooperation. Should the buyer have the market power to implement his own optimal policy as that
one to be used in the exchange process no incentive exists for him to choose a joint optimal policy. A joint policy can therefore
only be the result of a bargaining process between the parties involved. The supplier may make some sort of concession such
as a price discount or a side payment in order to influence the buyers order policy. A critical assumption made throughout in
supply chain literature is that the supplier has complete knowledge about the buyers cost structure. Clearly, this assumption
will seldom be fulfilled in practice. The research presented in this paper provides a bargaining model with asymmetric
information about the buyers cost structure assuming that the buyer has the power to impose its individual optimal policy.
2004 Elsevier B.V. All rights reserved.
Keywords: Production; Supply chain management; Coordination; Asymmetric information

1. Introduction
A supply chain can be considered as a network of different geographically dispersed facilities where raw
materials, intermediate products, or finished products are transformed and transportation links that connect the
facilities ([10, p. 15], [37, p. 5]). One of the major tasks of supply chain management is to coordinate the
processes in the supply chain in such a way, that a given set of objectives is achieved [39, pp. 8-9]. Most

Tel.: +49 69 7982 8201; fax: +49 69 7982 8414.

E-mail address: esucky@wiwi.uni-frankfurt.de
0377-2217/$ - see front matter 2004 Elsevier B.V. All rights reserved.
doi:10.1016/j.ejor.2004.08.039

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

517

commonly, the relevant objectives, pursued by supply chain management, are minimizing system-wide costs
while satisfying a predetermined service level [30, p. 835]. The complexity in coordinating the processes in
supply chains is introduced by the organizational structure within the network. In general, a supply chain is
composed of independent firms with individual preferences [7, p. 113]. Therefore, in contrast to the management
of multi-echelon systems, that coordinates inventory, production and distribution decisions at multiple locations
of one firm, supply chain management involves coordination of such decisions among multiple and independent
firms [27, pp. 794-795]. Bhatnagar et al. [5] identify the issue of coordinationat the most general level, which
they call general coordinationin integrating decisions of different functions. Within this problem of functional
coordination Bhatnagar et al. [5] as well as Thomas and Griffin [41] distinguish three categories: (1) supplyproduction coordination, (2) production-distribution coordination, and (3) inventory-distribution coordination. In
this paper we will focus on the first category, which is also called buyer-supplier coordination [41, p. 2]. For each
set of nodes in a supply chain, e.g. a location of a manufacturer and a site of an assembler, a supplier-buyer
relationship can be identified [2, p. 199]. Material flows from a supplier to a buyer while information and
financial flows are bi-directional. Both, in the scientific discussion and in practice considerable attention is paid to
the importance of a coordinated relationship between suppliers and buyers in supply chains. As Goyal and Gupta
[21] note, coordination between the supplier and the buyer can be mutually beneficial to both. Studies on buyersupplier coordination have focused on determining the order and production policy which is jointly optimal for
both. Using such a joint optimal order and production policyas opposed to independently derived policies
leads to a significant total cost reduction. However, there is an additional set of problems involved in
implementing joint policies.
In this paper we will analyze the typical case of a buyer-supplier relationship with a strong buyer. Should the
buyer have the market power to implement his own optimal policy as that one to be used in the exchange process
no incentive exists for him to choose a cooperative policy. To provide an incentive to order in quantities suitable
to the supplier, there exists the opportunity for the supplier to offer a price discount or a side payment to the
buyer. One critical assumption made throughout the literature dealing with incentive schemes to influence buyers
ordering policy is that the supplier has complete knowledge about the buyers cost structure. The research
presented in this paper offers a bargaining model with asymmetric information about buyers cost structure
assuming that the buyer has the market power to impose his individual optimal policy. The remainder of the paper
is organized as follows. Section 2 presents the review of the literature dealing with the problem of buyer-supplier
coordination. In Section 3on the basis of the well-known joint economic lot size model suggested by Banerjee
[4]we will show that from an individual point of view neither the buyer nor the supplier has an incentive to
choose a cooperative policy. We describe the quantitative losses due to a cooperative policy, both from the buyers
and the suppliers perspective. After that, we analyze the bargaining process between the parties involved. In the
first approach (Section 4), it is presumed that the supplier has complete knowledge about the buyers cost
structure. Afterwards, in the second modelpresented in Section 5we analyze a more realistic scenario. The
supplier has incomplete information about the buyers cost structure, i.e. the buyer can have different functions of
total cost, assumed by the supplier. We will present a self-selection model for the determination of the optimal set
of offers which are specifically designed for the buyers different cost structures.

2. Literature review
There is a large and growing stream of literature on buyer-supplier coordination. Most of the literature on
buyer-supplier coordination focuses either on deriving a coordinated order and production policy in the context of
a given supply contract, or on determination optimal contract parameters given the functional form of that
contract. In the last category, the primary focus is in design and evaluation of supply contracts

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E. Sucky / European Journal of Operational Research 171 (2006) 516-535

between independent buyers and suppliers in supply chains. Cachon [8] and Tsay et al. [42] provide comprehensive literature reviews of designing supply contracts. Corbett and Tang [12] study the design of supply
contracts in the presence of asymmetric information. In this paper, however, we will focus on the first category:
Coordinating order and production policies under a given supply contract. From the contractual perspective, we
assume that a fixed unit-price contract, often so called wholesale-price contract, exists between the buyer and the
supplier initially. Therefore, in the context of a given supply contract, the coordination of the buyers order policy
and the suppliers production policy does not affect the total volume provided to the buyer.
When the buyer and the supplier treat inventory problems singly under deterministic conditions, it is well
known that the economic order quantity (EOQ) formula or the economic lot size (ELS) formula gives an
individual optimal solution. However, in general, an order policy based on the EOQ solution is unaccept able to
the supplier, and likewise, a production and delivery policy based on the ELS solution is unaccept able to the
buyer [32, p. 312]. Each party has the lowest total relevant cost when their individual optimal order or production
and delivery policy is realized, but the other party experiences a considerable loss, compared to its own individual
optimal policy [33, p. 26]. The problem of buyer-supplier coordination has been emphasized in numerous
publications. Detailed reviews of available approaches for coordinating single buyer-single supplier systems are
given by Bhatnagar et al. [5], Goyal and Gupta [21], Sharafali and Co [38] and Thomas and Griffin [41].
In general, inventory decisions in a buyer-supplier system are made independently. That is, the supplier
determines its own optimal policy to produce and to supply a product and the buyer may also calculate its own
optimal policy to order from the supplier. As a result, the suppliers optimal delivery quantity may not necessarily
be the same as the buyers optimal order quantity. In that case, the adoption of the buyers optimal ordering policy
places the supplier at a cost disadvantage. Otherwise, the adoption of the suppliers optimal delivery policy is
disadvantageous from the buyers perspective. As a remedy, Goyal [15,18], Banerjee [4], and Landeros and Lyth
[29], present some models for coordinating buyer-supplier systems with centralized control. The researchers
suggest approaches for determining an integrated order and delivery policy, minimizing the joint total relevant
cost incurred by both parties. It is shown that in integrated models one partys gain resulting from the integrated
policy in comparison of the other partys optimal policy exceeds the other partys loss. Thus, the net benefit can
be shared by both parties (the supplier and the buyer) in some equitable fashion [21, p. 262]. While all models use
the accepted EOQ formula to determine buyers individual optimal order policy, the distinguishing feature is the
assumed production and delivery policy of the supplier. Goyal [15] was the first who introduced an integrated
policy for a single supplier-single buyer system. He assumes that the buyers demand is uniform with respect to
time, there is no lead time for the supplier and the buyer, and the supplier and the buyer cooperate with the
objective of minimizing the joint total relevant cost. The joint relevant costs are the costs of holding and ordering
at the buyers side and the set-up cost at the suppliers side. However, the effect of production rate on calculating
average inventory is ignored, by assuming an infinite production rate. Banerjee [4] generalizes Goyals model by
integrating a finite production rate. Therefore, the holding cost of the supplier will be considered by determining
the integrated order and delivery policy. Assuming a production rate greater than the demand rate, the supplier
makes the production set-up every time the buyer places an order and supplies on a lot-for-lot basis. Goyal [18]
relaxes the lot-for-lot assumption by considering that each production batch is dispatched to the buyer in an
integer number of equal sized sub-batches. In contrast to Banerjee [4] who assumes that the entire lot is conveyed
as a whole from the supplier to the buyer (sequential movement), Goyal [18] allows transportation of sub-batches
whose size may be larger than one unit and smaller than the entire lot (com bined movement). However, the entire
lot has to be completed before any shipments from that lot can take place. The possibility to produce more than
one shipment in a given production run does alter the suppliers average inventory as well as the number of
production set-ups. It is shown, that the joint

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

519

total relevant cost is further reduced. Landeros and Lyth note that Goyals model overlooked the processing cost
per shipment [29, p. 154]. Therefore, Landeros and Lyth [29] consider fixed delivery cost associated with each
shipment to the buyer. However, this approach does not generalize Goyals model. In the presence of centralized
control one simply has to increase the fixed order processing costs of the buyer by the fixed transportation cost
per shipment which does not alter the solution methodology. However, all models mentioned above assume that
the whole production batch must be finished before any shipments from the batch can take place.
Another class of models for coordinating buyer-supplier systems with centralized control allows the shipment
of sub-batches to the next stage before the whole lot is finished at the preceding one. Based on an idea of
Szendrovits [40] in the context of a serial multi-stage production system, this control policy was first applied in
the area of supplier-buyer coordination by Joglekar [25]. Agrawal and Raju [1] consider this case of a supplier
being able to ship a number of sub-batches before the whole production batch is finished. Analogous to
Szendrovits [40], they provide sub-batches of uniform size with a constant time allowance between any two
consecutive supplies. Based on a much earlier idea set out by Goyal [16], Goyal [19] provides an alternative
shipment policy, in which all sub-batches are in general of unequal size. This production and delivery policy
involves successive shipments within a production batch so that the size of the sub-batches increases according to
a geometric series. Chatterjee and Ravi [9] present an equivalent model considering fixed delivery costs
associated with each shipment on the suppliers side contrary to fixed transportation cost per shipment as a
component of the buyers fixed order processing costs. Viswanathan [43] shows, based on a simulation study, that
neither a policy with equal sized sub-batches nor a policy with unequal sized sub-batches dominates the other.
However, Hill [23] derives the structure of the true optimal solution for the sizes of the sub-batches for a single
supplier-single buyer system acting in a static deterministic environment. For the determination of the optimal
sizes of the sub-batches for the buyer-supplier system with centralized control see also Hill [22] and Goyal [20].
Nevertheless, neither the models with equal sized sub-batches nor the models with unequal sized sub batches
consider the power structure in buyer-supplier relationships. Three typical cases can be applicable:
(I) The buyer dominates the supplier. (2) The supplier dominates the buyer. (3) The buyer and the supplier have
equal power. In this paper we analyze the first case. If the buyer is strong, the supplier will be forced to accept the
buyers individual optimal order policy. In this situation, the supplier may make some sort of concession such as a
price discount or a side payment in order to influence the buyers ordering behaviour. The suppliers problem to
influence the buyers order policy has been analyzed by several authors, including Monahan [34,35], Banerjee [3],
Goyal [17], Lee and Rosenblatt [31] and Joglekar [25]. The authors compute a price discount which compensates
the loss of the buyer, if he changes his order policy to a cooperative policy. Miller and Kelle [33] and Kelle et al.
[28] also suggest some quantitative models to support negotiations in Just-In-Time supply systems. However, one
critical assumption made throughout in the literature dealing with supplier-buyer coordination is that the supplier
has complete knowledge about the buyers cost structure [11, p. 444]. Solely Corbett and de Groote [11] address
the bargaining process between a buyer and a supplier under asymmetric information. Other than the existing joint
economic lot-sizing literature assuming that the supplier has full information about the buyers cost structure, the
authors consider the situation that the buyers holding cost is unobservable to the supplier. Corbett and de Groote
[II] present a game theoretical analysis and determine an optimal discount scheme in order to influence the
buyers ordering behaviour. Nevertheless, the buyers ordering costs are assumed as common knowledge. In this
case, the problem of information asymmetry is eliminated. The buyers holding cost can be specified as an
implicit function of his ordering cost and his EOQ. Thus, if the supplier knows the buyers ordering cost and his
EOQ, the supplier can also derive the buyers holding cost. The research presented in this paper provides a
bargaining model with incomplete information about the buyers ordering cost and holding cost, assuming that the
buyer has the market power to implement his EOQ in case of a break-down in negotiations.

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E. Sucky / European Journal of Operational Research 171 (2006) 516-535

3. Ordering and production policies in the JELS model

3.1. Individual optimal policies
Following Banerjee [4], the discussion and analysis in this paper is restricted to the case of a single supplier
and single buyer of a specific product. The buyer and the supplier are separate and independent organ izations.
The demand for the product is assumed constant and deterministic. Shortages are not permitted at the buyers end,
and the time horizon over which the product is ordered by the buyer and supplied by the supplier is infinite. The
supplier fabricates the regarded product at a finite production rate. The transportation time between the supplier
and the buyer is assumed to be zero. The optimality criterion for the buyer and the supplier is the minimization of
their own total relevant cost per period. The buyers total relevant cost per period consists of the order processing
cost and the inventory holding cost. The suppliers cost function includes the production set-up cost and the
inventory holding cost. Both parties determine the economic order quantity or lot size using the well known
economic order quantity (EOQ) formula or economic lot size (ELS) formula [4, pp. 293-294].
3.1.1. Individual optimal ordering policy
The objective for the buyer is to determine the optimal ordering policy minimizing his total relevant cost per
period without shortages. We refer to him as party (A), and hence generally use subscript A to designate his set
of parameters or decisions. It is easy to see that for an optimal ordering policy every order, with quantity x A
[unit], is received precisely when the inventory level drops to zero [6, pp. 145-147]. The demand rate at the
buyers end is d [unit/period]. The inventory holding cost of (A) is h A [$/(unit and period)] and the order
processing cost amounts to B [$]. The total relevant cost per period of (A) is given by
K A { x a )= B + f Ha [$ /period].

A 2
The economic order quantity (EOQ),
[$/period], for the buyer (A ) are given by

(1)

/2 B d

XA

[unit], and the minimum total relevant cost per period, K A (X A )

KA (XA ) = \ J 2 B d h A .

(2)

3.1.2. Individual optimal production policy

The objective for the supplier is to find the optimal production policy minimizing his total relevant cost per
period. We refer to him as party (P) and use subscript P to designate the set of parameters or deci sions of the
supplier. The production rate amounts to p [unit/period], whereas the relation p > d will always hold. The
supplier follows a lot-for-lot policy, i.e. (P) produces the ordered quantity of the product and, on completion of
the batch, ships the entire lot to (A). The average inventory is given by X- p [unit] [4, p. 294]. The inventory
holding cost of (P ) is h P [$/(unit and period)] and the production set-up cost is R [$]. The total relevant cost per
period of (P ) is given by
Kp (xp )=R + d hP [$/period].
(3)
XP
2p
The suppliers economic lot size (ELS), xp [unit], and his minimum total relevant cost per period, KP(xp)
[$/period], are given by
X

2RpP

' = -hP~-

K(

*f) = d p-

2 R hP

(4)

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

521

3.2. Integrated production and ordering policy

If ( P ) follows a lot-for-lot strategy, the lot size corresponds to the quantity delivered. For (A), the order
quantity corresponds to the quantity delivered. Since we have excluded shortages by definition, an equal lot size
x G = x A = x P for (A ) and (P ) is the logical consequence. This leads to the inventory cycles for (A ) and (P ) as
represented in Fig. 1.
Banerjee [4] determines the joint lot size x G = x A = x P minimizing the joint total relevant cost for both the
buyer and the supplier. The joint total relevant cost of (A) and (P) for a joint lot size x G = x A = x P can be derived
from Eqs. (1) and (3) as follows [4, p. 299]:
KG(xG)=B + (( hA + R + Tr - hp [$/period].
xG 2
xG
2p

(5)

The joint optimal lot size, XG [unit], and the minimum joint total relevant cost per period, KG(x*G) [$/period],
are given by
xG =]j2 h- +^ .;R);

KG(xG)

2 - -(B + R) ^hA + P hfj.

(6)

3.3. Comparison of the individual and integrated policies

The relation of set-up cost of (P) to the ordering cost of (A) and the relation of the holding cost of (P) to the
holdings cost of (A) for any joint lot size x G can be expressed with the parameters a and b [4, p. 295]:
R R and b B
f P hP
2
pp
___
f hA
XG .
The following
relations can be derived:
a=

*
X

rb *

= a Xp;

*
p=

*
X

d hP
p hA

(7)

-A=

Fig. 1. Inventory cycles for (A) and (P).

(8)

522

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523

Table 1
Individual economic consequences of alternative policies

T O TAL RE L E VANT CO ST FO R
( PP)
K
( XP )=K P
(
X A ) = 1 '
h
K P
A
A uniform lot size x *A =
= xG only applies for A = ft. For A 5 B follows x(*A =A x+P , and
joint optimal
A ' the
P
P
K
(
X
)
=
K
2
'
R
P
lot size xG is located within the interval between the individual optimal solutions of (A) and (P), i.e.
( XP ) = D '
' H P
%a xXGP 2
' XxP_ A
Ka(xa)
KA(xp
]x_A,
[ if, xA
> xP= and
x)G =2 1]x' P ,( x A [+if xqfjA '> xP . In case
of A 5 B (xA = xPV) aPsolution with an uniform
X
A = X G = Y ' R P F '
K P ( XP )= K P
X
exists if (P) adapts to (A) (xP = xA = x(G )X * G ) = 1 (' A ) adapts
A > lot size x G = x A = xPK only
to
A ( X
P = x G) or
A ) = K A ( X G ) = 1 '
(
^ +(P) (x
^ )A '= Kxp
if
).
Fig.
2
exemplary
shows
the cost
X
X (A) and X(P) select another joint lot size, for example x G (xA = xP = x(
G
P = G = ' *
( X
( X
functions of (A ) and (P
of the joint total relevant cost and the individual
and integrated polI P ),
F +the
' K Afunction
A )
*)
icies in case of xA < xP .
R D E R
Q U A N T I T Y

T OTAL
( AA)
K ( XA )

L O T

R E L E V A N T

*
P

II

II

II

=
xP

A)

C O S T

F O R

'

B'd'

q q
q q

Deviations from the individual optimal policy always lead to an increase of relevant cost. From the suppliers point of view KP ( xG ) > KP ( xP ) applies for any joint policy xG = xP . In the same way,
K A ( xG ) > K A ( x_A) applies for any joint policy xG = xA from the buyers perspective. Using the relations (8)
the consequences of the alternative policies x A , xP and xG for (A) and (P) can be calculated (see Table 1).
The adoption of the buyers optimal ordering policy as the joint policy ( xP = xA = xG ) places the supplier
at a cost disadvantage: The relevant costs of (P) increase by the factor 1 ^ QB + in relation to his individual minimum KP ( xP ) . Otherwise, the adoption of the suppliers optimal delivery policy is disadvantageous from the buyers perspective. In case of xA = xP = xG , the relevant costs of (A) also increase by the
factor
2 (QB + Q in relation to his individual minimum KA ( xA) . The realization of the joint optimal
policy ( xA = xP = xG) leads to an increase of the relevant costs of (A) by the factor 2 Q
in
relation to his individual minimum KA ( xA) whereas the relevant costs of (P) increase by the factor
in relation to his individual minimum KP ( xP ) . With A 5 B and a,b >0, the following
2 +
^
relations can be derived:

2 rb ra
+

2 (rb+

f) >

/T+P
1 + a , > 1,

(9)

2 (Sr+b+sm > 1.

(10)

524

E.
E. Sucky
Sucky // European
European Journal
Journal of
of Operational
Operational Research
Research 171
171 (2006)
(2006) 516-535
516-535

525

min Kp (xG, z) = Kp (xG) + z

(11)
2 z 6 KaAtake-it-or-leave-it-offer
(P
makes
and the game is immediately terminated after acceptance or(12)
refusal of the
s.t. KA(Table
X
G))
(xA),
Exampl
offer
by
(A)
[14,
pp.
57-61].
(13)
ez1 P 0;
No transaction cost arise and (P ) has complete knowledge about the cost function of (A ).
xG > 0.
(14)
a = 1.35,
0 .6
X
X
X

O T A L R E L E V A N T
C O S T F O R ( A )

O T A L R E L E V A N T
C O S T F O R ( P)

Bargaining
( DA = 1 0 solution
, 0 0 0 , with
B = 1complete
0 0,
( PP
K ( XA) = 10 ,0 00
K
information

= 15 ,0 00 , R = 13 5,
( XA) = 97 50

O I N T

T O T A L

R E L E V A N T

C O S T

( A) A N D ( P)
K ( XA) = 19 ,7 50
P = 30 0
KA ( XP ) = 1 0, 83 3. 33
KP ( XP ) = 9 00 0
K G( XP ) =
In this section
will be analyzed, which joint policy
x G and associated side payment
1K 9G ,( 8X3Gz
3 ).are
3=3 offered to (A ) by
G = 2 42 .3 8
KA ( XG) = 10 ,1 85 .2 5
KP ( XG) = 92 05 .4 6
(P). (A) has the market power to implement his individual optimal policy x * A . 1If9 (A)
, 3 9behaves
0 . 7 2 individually raA =

2 00

F OG R

tional, no incentive exists for deviating from this individual optimal policy. Without negotiations xA will be
A
implemented,
with K(9)
(xA)
p2 show
B dthat
h Athe
and
K p (xA)from
= 2 the
^[ +individual
[^ ' KP (xp).
If(P) policy
offers(A)
ajointleads
policy
The inequalities
and =(10)
deviation
optimal
always
to xanG
increase
in
cost
by
a
factor
greater
than
one.
In
addition
to
that,
it
can
be
observed
that
the
increase
in
cost
against a side payment at a value of z, the following non-linear minimization problem is to be solved:
resulting of the other partys individual optimal policy is greater than the increase initiated by the implementation
of the joint optimal policy. Table 1 summarizes the individual economic consequences of alternative joint policies.
The analysis of the individual economic consequences of alternative joint policies shows that neither the buyer
nor the supplier have an incentive to choose a cooperative policy deviating from their individual optimal policies.
The buyer and the supplier are separate and independent firms. In this context, it is reasonable to assume that each
party will act in their own best interests. If (A ) and (P ) behave individually and rationally, they want to select
their individual optimal policies x A and xp in any case. Therefore, for a 5 b a joint policy x G = x A = x P can
The non-linear optimization problem given in (11)-(14) can be solved by using the Lagrangian approach.
only result from negotiations between the parties involved.
Nevertheless, the solution can be determined as follows: Regarding the minimization problem (11), for each given
policy x G >0 the transfer payment z should be selected as small as possible while satisfying restriction (12).
4. A bargaining game with complete information
Therefore, for each given x G the corresponding optimal value of z is exactly given at the point where (12) is
A
A
satisfied
as an equation.
4.1.
The bargaining
modelReplacing z in the objective function (11) by K ( x G ) K (xA) and minimizing the
resulting cost expression, the optimal offered policy and the corresponding side payment can easily calculated.
(A) andoffers
(P) behave
individually
rational,
individual
optimal
policies exactly
xA and the
x * increase
p . If (A) or
TheIfsupplier
the joint
optimal policy
(6)they
andselect
a sidetheir
payment,
which
compensates
in
(P ) has
market
power
impose its
individual
optimaloptimal
policy policy
on (P )xA:
or (A ), respectively, then no incentive exists
cost
of (A),
induced
bytodeviating
from
the individual
for either (A) or (P) to deviate from their individual optimal policy xA or xp. The weaker player must deviate
1
1 + a However
I1+
2 d optimal
(B
from his individual
adapt to the stronger players
policy.
if
negotiations
( B + R)policyz and
KA(x ) KA(x )
1
2 Bare
dpossible,
hA.
=
G
A
=
+
x
1 +af policy 1other
+ a than its individual optimal
the weaker player may try to persuade the stronger playery2to^ select
policy by a side payment. A side payment is defined as an additional monetary transfer between supplier (buyer)
and buyer (supplier) that is used as an incentive for deviating from the individual optimal policy [36, p. 22]. (15)
It is
to be
examined,
joint policy
x = he
x accepts
= x is this
implemented
if condition
(A ) and (P
) negotiate
on (A)
the realizes
joint order
If (A)
behaveswhich
individually
rationally,
offer,
since
(12)
is
fulfilled.
his
quantity and
size.
The bargaining
game(NK,A(xG)
U , u *+) K
isAdescribed
the The
set of
players
N = {(A),(P)};
the set
U
minimal
totallot
cost
KA(xG)
z = KA(xG)
(xA) = KAby
(xA).
offer
is attractive
for (P) only
if the
of feasible
payoff
(in this case
cost combinations)
u 2 U and the
u* 2 U realized
in the
total
relevant
cost combinations
plus the side payment
are lower
than with implementation
of threat
xA, i.e.point
the following
must apply:
case of a break-down in negotiations [13, p. 238]. The bargaining problem arises from the fact that at least one
cost combination u ' 2 U with the following property exists: u 6 u* for all players i 2 N ; u < u* for at least one
P
(16)
KA(xG)
KA(xA)
Kpbe
(xA).
playerKi (xG)
2 N .+The
bargaining
game<to
examined can be described as follows:
G

2 - S+ S+l
(

K P W)+

(2 - (S+b rm
+

Condition (16) can be transformed:

(A) has the market power to implement his optimal policy, i.e. x G = xA results in case of a break-down in
negotiations. The threat point is given by u* = (KA(xA), K p(xA)).
KP at
For (A ) to select a policy other than his individual optimal policy x *A the increase in total relevant
KA(xA) <cost
2 must
(r+ra)be
).
least compensated by a side payment from (P ). Thus, (P ) offers (A ) a joint policy x G with an associated side
payment at a value of z [$/period]. The feasible cost combinations are given by u = (KA(xG) z,K ( x ) +(17)
z),
for x >0, z P 0.
It can be shown that condition (17) is satisfied for all a 5 b and a, b >0, i.e. (P ) realizes a bargaining surplus
Vp (xG) at a value of:
P

vp (xG)

KP (xA) Kp (xG) z = Kp (xA) Kp (xG)

KA(xG)+KA(xA) > 0.

(18)

( P ) behaves like a master planner and selects the joint optimal order quantity and lot size x G . With complete
information negotiations based on the assumption made, lead to the joint optimal order quantity and lot size. It
can be shown that this result is independent of who possesses market power to implement its individual optimal
policy. Likewise it can be shown that this result is also independent of who makes the take- it-or-leave-it-offer. A
fundamental principle illustrated here appears to apply to most, if not all, single source purchases: if the two
parties negotiate cooperatively, with complete information, a side payment will lead to a contract from which both
parties will benefit [36, p. 25]. With respect to the work of Banerjee [3], it has to be noted that a solution identical
to the presented one can be obtainedas was shown by Banerjee [3]if the supplier grants an appropriate allunit quantity discount to the buyer, provided that the buyers holding cost h A does not depend on the unit price
which the buyer has to pay to the supplier.
4.2. A numerical example (1)
Consider the information for the buyer (A) and the supplier (P) given in Table 2. The buyer (A) selects his
optimal policy x * A = 200 and realizes his minimum total relevant cost K A(xA) = 10,000. Without bargaining, the
suppliers total relevant cost are KP(xA) = 9750. Therefore, the supplier (P) offers the joint optimal policy xG =
242.38 and a side payment z = KA(xG) KA(xA) = 185.25 which exactly compensates the increase in cost of (A)
induced by deviating from xA = 200 to xG = 242.38. It is individually rational for the buyer (A) to accept this
offer: KA(xG) z = 10,000. Then, (P) realizes K P (xG) +z = 9390.71 and a bargaining surplus of V P (xG) =
KP(xA) KP(xG) z = 359.29.

5. A bargaining game with asymmetric information

5.1. The bargaining situation with asymmetric information
In the preceding paragraph it is shown that a joint optimal policy xG results from a bargaining process
between the buyer and the supplier. This results however from the assumption that both players involved have
complete information, and can design the side payment scheme accordingly. The results change, as soon as the
players have private information about their cost functions. In the following it is analyzed which bargaining
solutions will be implemented if the players have incomplete information. Furthermore, we as sume that the buyer
has market power to impose his optimal policy xA on the supplier. However, it will be also assumed, that the
supplier has asymmetric information about the buyers cost structure, i.e. (P) possesses incomplete information
about the type i 2 I of the buyer. The buyer (A) will only select a policy other than the individual optimal policy
xA, as was shown, if the increase in total relevant cost resulting from this policy is compensated by (P ).
Therefore the knowledge of the buyers cost function is of the highest interest for the supplier ( P ). However, (A )
has no incentive to report truthfully on his cost structure [26, p. 493]. Moreover, the buyer has an incentive to
overstate his own total relevant cost in order to obtain a side payment z as high as possible. In order to bring (A)
to a truthful report, (P) can employ screening: the supplier (P ) determines several offers which are specifically
designed for the different assumed types of (A ). These

526

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

offers must be designed to be incentive-compatible, so that they are attractive for each assumed type of ( A ) to
choose the offer which is designed for that specific type of (A) [24, pp. 561-562]. By accepting one of these offers
(A) indirectly reports truthfully about his cost situation. In the following, from the point of view of (P), it will be
assumed that two alternative cost functions of (A) are possible: Kf (x) and Kf (x), i.e. from the view of (P) two
different types of buyer (A) exist: (A1) and (A2). Type of buyer (A1) is characterized by the inventory holding cost
hA1, the order processing cost B 1, and the individual optimal order policy xf 1. Accordingly, for the type of buyer
(A2), we use hA 2, B2, and xf 2. In the following section, for calculating the optimal set of offers, we take the
reasonable assumption that the inequation hA1 5 hA 2 will always hold.
5.2. The screening model
The following bargaining game has two stages: in the first stage, (P ) makes an offer, and then, in the second
stage, (A ) can either accept or reject. After that, the game ends. Both players (A ) and (P ) are assumed to be riskneutral. From the suppliers point of view two different types of buyer (A) exist: With a probability of ro 1 > 0 the
buyer is type (A1) and with a probability of m 2 = 1 m1 > 0 type (A2). With complete knowledge about the
buyers cost structure, (P) would offer the joint optimal policy x * G and a side payment z which compensates for
the increase of cost. Not being informed about the buyers true cost structure it will be optimal for (P) to offer a
set of offers (x1, z1, x2, z2), i.e. two separate joint policies x1 and x2 with corresponding side payments for the
assumed buyer types (A1) and (A2). If (P) does not do this and only offers the joint optimal policy for type (A 1)
while (A) is the type of buyer (A 2), it is possible that there is an incentive for type (A 2) to disguise itself as type
(A1) to realize a profit Kf (x 1) Kf (x1). To avoid that, (P) has to offer joint policies x 1, x2 and side payments z1,
z2 which guarantee that each type of (A) accepts the adequate offer. The non-linear optimization problem of (P ) is
to minimize the expected value of his total cost:
min E[KP(x1, zb
s.t.

X2, Z2)] = 1 (KP(X1) +Z1) + m2 (KP(X2) +Z2)

(19)

K (x1) Z1 6 K (xf 1),

(20)

Kf(x2) Z2 6 Kf(xf;2),

(21)

(22)

(23)

K (x1) Z16 K (x2) Z2,

K (x2) Z2

6 K (x1)Z1,

Z1, Z2 P 0,

(24)

x1; x2 > 0.

(25)

Conditions (20) and (21) ensure individual rationality: for both assumed types of (A), it must be more
attractive to accept the offer than the threat point. Conditions (22) and (23) ensure incentive-compatibility, so that
it is attractive for each assumed type of (A ) to choose the offer which is designed for that specific type of (A).
The cost functions KP(x1) and KA(x1) are strictly convex in x1 and the cost functions KP(x2) and KA(x2) are strictly
convex in x2. Therefore, the Karush-Kuhn-Tucker-conditions (see Appendix A) are sufficient for an optimal
solution. Using the Karush-Kuhn-Tucker-conditions the optimal set of offers can be determined. The analysis of
the Karush-Kuhn-Tucker-conditions leads to six possible sets of offers (see Appendix A). The set of offers which
satisfies all Karush-Kuhn-Tucker-conditions is a feasible solution satisfying the constraints (20)-(24) and is also
the optimal solution of the minimization problem (19).
Set of offers 1
x1 =

2 d (B

R)

with Z1 = Kf (x1) Kf (xf ;1),

(26)

U P P L I E R

(P )

KA (

hA1 = 5 0

1 00 ,

Y P E

O F

50 ,

ii
(

B ,

( A1)

B U Y E R

=9 00 0

528
530

10 ,0 00

K A (

B U Y E R

( A2)

10 0

, 2)

O
O

O F

II

R = 1 3 5 , hP = 4 5

Y P E

1 0, 00 0

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

527
531
529

)_Kf X
+ R With Z = K f
TableThe
6.3 x2 values
Conclusion
= \ ^ hKdof
' +alld)-K
hLagranges
2
^multipliers
( A,2)-k , k , i1 and i2 can2 either
be zero or greater
2(x
2,2 the
f(XA,l)
' K2 (xA,21 ) K12 (xA,1
A
' (B1 B2)' d
Example
2
16 possible combinations exist for the Lagranges multipliers k , k , i and i (see Table 4).z

(27)
than zero. Therefore,
(x ) K (x
1
2 1
2
X

with
= K2JELS
2
2 A,2)
1 ^ hA,2
\2 = joint policies
Offered
are side
equal
to the
joint
optimaland
policy,
which
be derived
fromz2the
model
thea
In case
this paper
a joint
order
lot
size
in can
a single
buyer-single
system
as
of x Awe^ propose
xp the
payments
zquantity
to be
greater
than
zero.
With
z2 > 0 and
the or
KKT1 and z2 have
1, supplier
presented
bargaining
game
with
complete
information.
The
offered
payments
z
and
z
compensate
exactly
the
1
2
bargaining
solution
the follows:
basis of Banerjees JELS model. It is well known that the joint optimal policy will
conditions (A.4)
andon
(A.5)
(33)
= by the transition from x=f ^ to x1 or from xf ,2 to x 2 . The optimality test of the set
increases
of
cost,
induced
of
always X
result
in
savings
1k
I1 T I2 in0total
and system
X2 kcost.
2 T hHowever,
12 0-should one of the parties involved, the buyer or the supplier,
(A. 10)
In
this
case
the
imitation
of
(A
(A
prevented
only
by
a
unattractive
policy
x
x
,
x
>
0
result
2) by
1) is
2. For
2lan
22
offers
1
is
described
in
Appendix
A.
The
set
of
offers
1
is
not
the
optimal
one
if
the
buyer
has
incentive
to
have the more powerful position to enforce its individual optimal policy no incentive exists for this party to choose
Itsets
applies
ro1, m
> 0, is
with
1
ro
>his
0. true
Conditions
(A.10)
show
thattest
allof
combinations
fortwo
the
Lagranges
2 which
2 =be
two
offers
4,
have
to
proofed
for
optimality.
The
optimality
thedistinguish
offers
4 is
described
aof
contract
which
notrodesigned
for1 case:
structure.
Thereby
we
can
cases:
First,
achoose
cooperative
policy.
We consider
a typical
Thecost
buyer
dominates
the supplier.
Ifset
theofbuyer
has
the
market
multipliers
with
k1true)
= hcost
0function
and k2 (33),
= h(A)
= is0 Kare
infeasible
regarding
the
KKT-conditions.
Furthermore,
from
1 = equation
2 note
in Appendix
A. his
Regarding
webut
have
taken
reasonable
fortooffer
the
screening
the
trueto(or
nearly
f (x),
thethen
buyer
has
an incentive
to accept
the
which
is
power
impose
individual
optimalofpolicy
onthat
the
supplier
nothe
incentive
existsassumption
for
the buyer
deviate
from
(A.10)
results:
model
that
is,
to
presume
that
the
inequation
h
5
h
will
always
hold.
A1
A 2 (A1) has an incentive to imitate (A 2). Second, the true (or
designed
on the
basis of
the
cost
function
K
f
(x),
i.e.
his
individual
optimal
policy.
A
joint
optimal
policy
can
therefore
only
result
from
a
bargaining
process.
The
=
=
=
2 ^2 T X1 k 0 ( ^ X1 T X2 k T ^2 ( ^ 1 k T ^2.
(A. 11)is
nearly Xtrue)
cost function
the offers
buyer is
K f (x), butmodel
the buyer
an incentive
to acceptonthethe
offer
which
research
presented
in this of
paper
a bargaining
withhas
asymmetric
information
buyers
cost
Set
of
offers
5
designed
on the(A.11)
basis
the buyer
cost
f (x). Inpower
both cases
would
disguise
as theshown
othertothat
type
in
Conditions
shown
thatfunction
all combinations
with
kto1 implement
= the
k2 =buyer
0 are
infeasible.
Thisitself
analysis
leads
eight
structure
assuming
thatof
the
has
the Kmarket
his
optimal
policy.
It was
the
order
toset
gain
profitwill
ofofbe
imitation
K f (xif1)the
supplier
Kf (x2)+z
Kf (xj)5).
For
K
f(xthese
. eight
To structure
avoid
that,
the
sets ofasoffers
feasible
combinations
the
Lagranges
multipliers
(see
Table
feasible
combinations
six
2 or
1)+z1cost
optimal
of aoffers
determined
can
estimate
the
possible
of
the
buyer
well
2(x
)-KA(x
)
K (x
) K (x
2 (B B ) d
2,1
number
2sets
to 6ofKare
designed.
possible
offers
canA,2
be derived
for the
'well.
1supplier.
A,1
2 A,2 A
2 the
1 screening
'
as
the associated
probabilities
sufficiently
The supplier
can employ
model developed above as a
h
h
with Z1 = K2 (x1)- K2 (xA,1),

11,2
A,2
^
A,1
quantitative tool supporting contract negotiations.
Experiments
with
different
combinations
of assumed cost
hA,2 - hA,1
hA,2 - hA,1
structures and associated probabilities enables the
supplier
to
derive
a
good
set
of
offers.
Thus,
we conclude that
- 1i +12information
P 0 and Z 1 of both (xi
kithe
li + 12) = 0,
(A.
4)
(34)a
complete
players,
buyer
and
the
supplier,
does
not
represent
a
necessary
prerequisite
for
A.1.
Determination
of
the
set
of
offers
1
Set of offers 2
(x
1 )
bargaining
X2 - k2
+ ii x- i2 Psolution.
0 and Z 2
2 - k2 + li 2 = 0,
(A.5)
(35)
= 2'^
,^R) with Z2 = KA(x2)-KA(xA,2)For2the
first(x1
case
0, i1 =B0,
i2
= 0) the set of offers can be derived as follows. From conditions
1 >0,
2B>
-K
X

2
1
2,2 R(k
P 1k
^
p
x
k
) Zz1)
1) Kf (xf ,1),
with
(28)
KA (A.10)
- Kf 1(x
PB2
1 = xKf
0,(x
i)+ hZ11 =
and
h02)and
= d0 followsi k 1 =(KA(xA,i)
x 1 and k2Kf(xi
= ro
With
2. +
1, x
2 >0, i1 = i2 = 0, k 1 = x 1 and k(A.6)
2 = m 2 the KKT0J
(xf,i) conditions
h

h to:
In this case
of
by2 (A
only by anfrom the point of view of KA (x)unat(A.2)
(A.3)
2the
and
p imitation
p + 72 reduce
2 (A
f ,12) +
h2f),1is prevented
K (x
)
k
2 A,2
- Kf(xchanged
and
2 x11(Kf(xA,
) Kf(x2
2) = 50,Ahave to be proofed for optimality
(A.7)
tractive
x1. For
, x12 > 02two
sets )+
ofZoffers
(see Appendix
2)+z2 P 0 quantity
Appendix A 2(X
0Kp(x1)_
8 K (xt)
d1) | x(B2 +0K
R)j ( x 1 )-_ 0 ^
A). x
(29)
Kf(x
2
)

Kf
(x
1
)+Kf(x
1
)Kf(xf,
1
).
with
z
2 f
h 1
8x
8x1
8x) 0;
Z
f ,2 + p hP 8x1 li 2(Kf(x2)
Kf (X2) -ZThe
-Z2
K
A
+
i
=
(A.8)
2 - K (xi)+zi P 0 and
optimization problem Fig.
with3. Joint
constraints
(19)-(24)
can assumed
be transformed
optimal policies
for different
types of (A).to the following unconstrained
(xi)
p
p
minimization
problem:
8
K
8
K
(x
)
8
K
A
(x
)
8
KA
2
2
Imitation
of
(A
)
by
(A
)
will
be
avoided
by
offering
anfrom
the
(x)unattractive
Kf (xi)Set
- - of
Z 1 offers
- Kf (x62) + Z 21 P 0 and 2
l2 0(Kf(x1) -Zi
- Kf
+ Z2) = 0. point of view of Kf(A.9)
(A-13)
(x
2)
ox
o x the joint optimal
policy x1L
, which
deviates
from
policy
determined
by
the
JELS
model.
Additionally,
the offered
(x
P)
2 i, X 2, Z 2) = X2 (K P (X i)+Z i) + 2 (X
2)
2
(
X i, Z
(
K
(
X
2
)
+
Z
2
)
ki
p (K f(X Ai) -K f(X i)+Z i) - k2 (K 5x ^2 )
8
x
2
icy.
Without
bargaining,
the (xtotal) relevant for
cost of increase
the
(P) are
* x) =transition
9750 if the
buyer
(Ax)a
) K supplier
(x
2 (B K (Bx by
payment
z2 consists
of cost,
from
xf 2istotype
x2 and
K (x of ) the
8x2induced
' K1- (xlithe
A,1
2i) + Z
1 i))' Ad- the
1 A,1 K2compensation
A,2
f 2 A,2 A
f
K
^(X
2
)
+
Z 2)(A

(
Kthe
(
Xset
2) -ofZoffers
2 value
K f 2(Xof
l2

(
K
(
Xwith
i)
ZZi1A.
KK
^(2X
21bargaining
)
+
Z22(x).A,1),
= 2) = 15,000 if the
and
Kxp11,2
(x_A
buyer
is
type
The
expected
the
suppliers
total
cost
without
2).
=
(x
)K
bonus
for
not
imitating
(A
).
The
optimality
test
of
is
described
in
Appendix
h
-h1
A,1
amounts to E[KP(x1 A,2
= 200,z
the
1 = 0,x2 = 100,z2 = 0)] = 12,375. In this example, the set of offers 4 is optimal for(A.i)

supplier:
( x 1 3= 242.38,z1 = 185.25, x2 = 141.42,z2 = 606.57). The expected value of suppliers total cost amounts
Set of offers
(36)
P
P
to:
E[K
Table
4 (x1,z1, x2,z2)] = 10,832.31, i.e. the supplier (P) realizes a bargaining surplus of E[V (x1, z1, x2, z2)] =
With
xi,combinations
x2 > 0 2the
(KKT-) conditions can be deduced as follows:
Possible
for
the1Lagranges
multipliers
dKarush-Kuhn-Tucker (B
+ R)
1542.69.
x
K (x
(x 1) )
K Kf
Kf
B ) (xf
=
(xA
2)+ Kf (x2 2'(B) 1
with
z
(30)
K2(x
)
K
2
(x
1
1
h
h ~
'Kf
2(A
2,2
1 (x2,1
2 ' d ,2),
2,2
.2,1) for type
,1
+ cost
p, 0Kf(xi)
Pfunctions
Fig. 3 shows
the
policies
1), type (A
2) and (P), the individual optimal
t, xA) 2, xp
0KA(xi)
with
z
K2(xxA
) K2(x
0Kf(xi)
0KP f(xi)

2
=
2
2
,2
(37)
21,2
(A.
2)
x1 joint policies
h
+ xki1, x2h2,2
+ ^i
0h2,1 h2,2
0xhi 2,1 ^2
and the
in
example.
2,2 0xi
0Xthis
0xi ^2,1
i
In summary it follows that the screening
between
the possible buyer types (A 2) and (A1) succeeds, if the
with z
(x2 R + a > A2 B1 + JB1) ,d
2 = Kf (x2) Kf (xf ,2) .
P
x
supplier
,
(31)
OKAM
0Kestimate
(x
2 can
2) -+ v 0KA(X2)
0Kf(x2)
B
2
+
2

hf
,2
(A.3)
x
0 an incentive to accept the offer designed
+that
^2 the buyer
li special
0X2
0X2
2 d6 hisxhp
2
1
\
h
0X2
Set2of offers
designed
for
the
case
has
on
Xhf;1
0
Tcost
p structure
+ 2" of22the
buyer and
(1)thethe
possible
basis
of
K2(x)
when
his
true
cost
function
is
K2(x)
and,
simultaneously,
the
buyer
has
an
incentive
to
accept
Theprobabilities
set of offersx13and
is designed
for theexact.
case that the buyer has an incentive to accept the offer which is designed
(2) the
x2 sufficiently
the the
offer
designed
on the
basis of
if histhetrue
cost function
K2(x). isThe
(P)offers
can deter
minethe
an
on
basis
of the cost
function
KfK2(x)
(x) while
buyers
true cost is
function
Kf supplier
(x). Set of
3 avoids
optimal
set
of
offers
for
the
assumed
cost
functions
K2(x)
and
K2(x)
of
(A):
the
set
of
offers
which
satisfies
the
imitation
of
(A
)
by
(A
)
on
the
one
hand
by
offering
anfrom
the
point
of
view
of
Kf
(x)
unattractive
policy
2
1
Regarding the
influence
of the probabilities x1 and x2 on the optimal set of offers we know that the set of offers
isone
theofoptimal
set oftheFor
offers.
If the set
buyer
behaves
rationally,
isofattractive
for
2and
. On3 the
hand,
the sideby
payment
zthese
1 exceeds
compensating
ofofthe
increases
of
cost
buyers
side,
2xKarush-Kuhn-Tucker-conditions
are other
directly
influenced
values.
example,
offers
2as
well
asatitsetthe
offers 5is
each
type
of
(A
)
to
choose
the
offer
which
is
designed
for
that
specific
type
of
(A
).
The
expected
value
of
induced
by
deviating
from
the
individual
optimal
policy
xj
to
x
.
The
optimality
test
of
the
set
of
offers
3
is
1
designed for the case that (A 2) has an incentive to imitate (A 1). Imitation
of (A1) by (A2) will be avoided onlythe
by
suppliers in
bargaining
surplus
is given by the difference between the expected value of his total relevant cost with
described
Appendix
A.
offering an unattractive policy x1 (set of offers 5) orin addition to thatby a side payment z2 which contains a
and without bargaining.
bonus for not imitating (A1) (set of offers 2). If the supplier assumes a relatively low probability x 2 for (A2) and
Set of offers
4 probability x1 for (A1) it is advantageous for the supplier to offer set of offers 2, because x 1 in
therefore
a high
5.3.
A
numerical
this set of offer is example
closer to(2)
the joint optimal policy as x 1 in the set of offers 5. Knowing this circumstance the
2

d
(B1 with
+ R) different combinations of the probabilities.
supplier
can experiment
x
Kfof(xf
),
with z1 forKf(x
h following information
Consider
the
both1)types
a ,1buyer
(A) and a supplier (P) in Table 3, with x1 =(32)
x2 =
1
f ,1 + p hp
0.5, d = 10,000 and p = 15,000. The buyer has the market power to implement his optimal polx

A S

E
K
K

1
2

11
1 2

1
=
=
=
=

0
0
0
0

2
>
=
=
=

3
0
0
0
0

=
>
=
=

4
0
0
0
0

=
=
>
=

5
0
0
0
0

=
=
=
>

0
0
0
0

6
>
>
=
=

7
0
0
0
0

>
=
>
=

0
0
0
0

8
>
=
=
>

9
0
0
0
0

=
>
>
=

0
0
0
0

10

11

=
>
=
>

=
=
>
>

0
0
0
0

0
0
0
0

1
>
>
>
=

2
0
0
0
0

13

1 4

1 5

=
>
>
>

>
=
>
>

>
>
=
>

0
0
0
0

0
0
0
0

0
0
0
0

1
>
>
>
>

6
0
0
0
0

A B L E 5
E L E V A N T
C O M B I N A T I O N S

A S E

O F
K

4
5
6
7
8

K
K

K
K
K

>
>
=
>

0
0
0

0
[ = 0
> 0
> 0
> 0

> 0
K 2 > 0
K 2 = 0
K 2 > 0
K 2 > 0
K

2
> 0
= 0
> 0

11
11
11

11

1 2
=
=

0
0

1 2

1 2

1 2

O O O O
A A A A

K
K

M U L T I P L I E R S

O
A

1
2
3

T H E

V T V TV TV TV T
S : S :KS :R

T
R

532

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

Conditions (A.12) and (A.13) represent the first-order conditions for the joint economic order quantity and lot
size as presented in Section 3.2. The offered joint policies are given by (26) and (27). They are equal to the joint
optimal policy, which can be derived from the JELS model. With k1 > 0, k2 > 0 and the KKT- conditions (A.6) and
(A.7), the offered side-payments can be derived: z1 = Kf(x1) Kf(xf;1), z2 = Kf(x2) Kf(xf.2). The set of offers 1
(see (26) and (27) in Section 5.2) satisfies the KKT-conditions (A.2)-(A.7). The set of offers 1 is feasible and
optimal if the KKT-conditions (A.8) and (A.9) are satisfied. Considering the side payments according to (26) and
(27) the optimality criteria for set of offers 1 are given by:
Kf (x2) Kf (X2) + Kf (x2) Kf (x*) p 0,

(A.14)

Kf (x1) Kf(x1)+Kf(x1) Kf(x2) P 0.

(A. 15)

A.2. Determination of the sets of offers 2 and 3

For the second case (k1 >0, k2 = 0, i1 = 0, i2 > 0) the set of offers can be derived as follows. From conditions
(A.10) and k2 = l1 = 0 follows i2 = k1 ro1, i2 = m 2 and m 2 = k1 x1. With x1 + x2 = 1 it follows that k 1 = 1 and
i2 = 1 x1. For x1, x2 >0, k2 = i1 = 0, k1 = 1, i2 = m 2 and i2 = 1 x 1 the KKT-conditions (A.2) and (A.3) reduce
to:
-KP (x1) -Kf(x0
-KP (x2)
-Kf (x2)
- + 2 -
OX2
OX2

0Kf(x1)
-+ L (1 x1)^^
0

-KP
(x2)
0X2

0,

(A.16)
-Kf (x2)
-X2

(A.17)

Condition (A.17) represents the first-order condition for the joint economic order quantity and lot size. The
offered joint policy x2 and the joint optimal policy are identical. With (A.16),
-Kf (x1)
B2 d 1
B1
+ ^ hf ,1;

d
5-----= 7vT + hf .2
(x )2
ox1
(x1)2 2
1
follows x 1 according to (28). The side payments z 1 and z 2 in accordance with (28) and (29) can be determined
using the KKT-conditions (A.6) and (A.9). The set of offers 2 satisfies the KKT-conditions (A.2)-(A.6) as well as
(A.9). The set of offers 2 is feasible and optimal if the KKT-conditions (A.7) and (A.8) are also satisfied.
Therefore, with (A.7) and (A.8) the optimality criteria for the set of offers 2 are given by:
Kf (X1) Kf (X1) Kf (x*)+Kf (x2) P 0,
(A.18)
-KP (x1)
-x1

R d 1d
(x1)2 2 p

-Kf (x1)
-X1

Kf (X2) Kf (X2)+Kf (X1) Kf (X1) P 0.

(A.19)

The set of offers for the third case (k 1 = 0, k2 > 0, i1 >0, i2 = 0), i.e. set of offers 3, can be derived in a similar
manner. The set of offers 3 is feasible and optimal if the KKT-conditions (A.6) and (A.9) are satisfied.
Now, we will analyze case 4, case 7 and case 8 of the feasible combinations for the Lagranges multipliers (see
Table 5). In the 4th, 7th and 8th case k 1 > 0, k2 > 0 is given. Therefore, the side payments z 1 and z2 for these cases
can be determined using the KKT-conditions (A.6) and (A.7), i.e. z1 and z2 are exactly at the points where the
conditions (20) and (21) are satisfied as equations: z 1 = Kf (x1) Kf (xf 1), z2 = Kf (x2) Kf (xf 2). The
optimization problem (19)(25) reduces to:

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

533

min E [ K P (xi,zi,x 2 , z 2 ) \ = X [ k p (xi) +Kf(xi) -K+ 2 (K( x 2 ) + -K^xA^))

(A.20)
s.t. Kf(x2) - K

( x * A a ) -Kf(xAi) p 0,

(A.21)

KA(xi) - Kf (xi)+ Kf (xf,i) - KA (xf,2) P 0.

(A.22)

( x 2) + K

For the non-linear minimization problem (A.20)-(A.22) the KKT-conditions are given by:
x1

0KP fo) | _ 0KA (x1)

+ Xi
0x1
0x1

X2

0KP (x2)
0KA (x2)
+X
0x2 ' 2 0x2

0KA (x1)
1
0x1 + '

11

0KA(x2 1
+
0x2)

0KA (x1)
0x1
0KA(x2)
0x2

(A.23)

(A.24)

KA(x2) - KA(x2)+KA(xA,2) - KA(xA,i) P 0,

(A.25)

11 (KA(X2) -KA(x2)+KA(xA,2) -KA (xA,i)) = 0,

(A.26)

KA(xi) - KA(xi)+KA(xA,i) - KA(xA,2) P 0,

12 (KA(x1) -KA(x1)+KA(xA,1 ) - KA (xA,2^ = .

(A.27)
(A.28)

A.3. Determination of the sets of offers 4, 5 and 6

In the 4th case (k1 >0, k2 > 0, i1 >0, i2 = 0) the KKT-conditions (A.23)-(A.28) reduce to:
x1

0KP(xi) ,

+ Xi

0KA(xi)

0,

(A.29)

0KP fo) ,
0KA
0KA(x2)
8KA(x2)
X (x2)
1i 0x2 + 1
2
0x2
+X
0 x2
0 x2
KA(x2) - KA(x2)+KA(xA,2) - KA(xA,i) = 0,
KA(xi) - KA(xi)+KA(xA,i) - KA(xA,2) P 0.

0,

(A:30)
(A.31)
(A.32)

The set of offers 4 (see (32) and (33)) can be determined using (A.29) and (A.31). The set of offers 4 is
feasible and optimal, if conditions (A.32) and (A.30) and 11 > 0 are satisfied. With (A.30) and 11 > 0 the following
optimality criterion results:
2 J - hP + hA,2

2 (hA,1

-h

A,2

- (R
)

+ ( 2B

Jr

> 0.

(A.33)

The set of offers for the 7th case (k1 >0, k2 > 0, i1 =0, i2 > 0) can be derived in a similar manner to the set of
offers 4. The resulting set of offers 5 (see (34) and (35)) is the optimal set of offers if the KKT-con- ditions (A.23)
and (A.25) and 12 > 0 are satisfied. For (A.23) and 12 > 0 the following condition must be satisfied:

534

E. Sucky / European Journal of Operational Research 171 (2006) 516-535

x

i 1 p h p + h A ;\ {R + B i) - X
2 {hA,2 hA,1) + {B1 B2)-X2 >

For the 8th case (k1 >0, k2 > 0, i1 >0, i2 > 0) set of offers 6 follows (see (36) and (37)). The set of offers 6 is
feasible and optimal, if the conditions (A.33) and (A.34) are satisfied. Finally, it can be shown that in the 6th case
the resulting set of offers is identical to the set of offers 2 and in the 5th case the set of offers is identical to the set
of offers 3.

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