Course: Supply Chain Digitization — Module 3: Digital Business in SC
NV decision: How much to order (S) from Regional Supplier, given known demand (D).
NV profit formula: min(D, S) × ₹20 − S × ₹10
RS profit formula: S × ₹5 − ₹1,50,000 | Breakeven at S = 30,000 units
Decision sequence: NV orders first → RS decides whether to accept or reject.
Information asymmetry: NV knows market demand D. RS only knows the order size S placed by NV — RS does not see demand directly.
Why the NV never deviates from S* = D:
Direction Cost of Deviation Order more than D Each unit beyond D is purchased at ₹10 wholesale but generates ₹0 revenue → pure loss Order less than D Each unit short of D is a missed sale of ₹20 net revenue (₹30 price − ₹10 distribution)
Scenario Demand (D) NV Best Order (S*) NV Max Profit NV Payoff Shape Will NV Choose S*? 1 0 S* = 0 ₹0 Any order > 0 → loss. Order nothing = ₹0. Yes — order nothing 2–4 2,000 S* = 2,000 +₹20,000 Rises to peak at S=D=2,000, falls on either side. Ordering 40,000 → −₹3,60,000. Yes — match demand 5 30,000 S* = 30,000 +₹3,00,000 Rises steadily to peak at S=30,000. Any order beyond reduces profit. Yes — match demand 6 40,000 S* = 40,000 +₹4,00,000 Rises to peak at S=D=40,000, then falls. Ordering 5 lakh → deeply unprofitable. Yes — match demand 7 5,00,000 S* = 5,00,000 Maximum Rises to peak at S=D=5,00,000. Would go higher if no upper demand bound existed. Yes — match demand
The table below shows NV profit (₹) for every combination of demand scenario and order quantity S:
Scenario Demand S=0 S=1,000 S=2,000 S=3,000 S=5,000 S=10,000 S=20,000 S=30,000 S=40,000 S=5,00,000 1 0 0 −10,000 −20,000 −30,000 −50,000 −1,00,000 −2,00,000 −3,00,000 −4,00,000 −50,00,000 2–4 2,000 0 +10,000 +20,000 +10,000 −10,000 −60,000 −1,60,000 −2,60,000 −3,60,000 −49,60,000 5 30,000 0 +10,000 +20,000 +30,000 +50,000 +1,00,000 +2,00,000 +3,00,000 +2,00,000 −44,00,000 6 40,000 0 +10,000 +20,000 +30,000 +50,000 +1,00,000 +2,00,000 +3,00,000 +4,00,000 −42,00,000 7 5,00,000 0 +10,000 +20,000 +30,000 +50,000 +1,00,000 +2,00,000 +3,00,000 +4,00,000 +50,00,000
Reading the matrix: Bold values show each scenario’s profit-maximising order (S* = D). Every row’s peak is at the column where S equals the row’s demand level — confirming the universal rule S* = D.
Key observation: Ordering at S > D always reduces NV profit. The S = 5,00,000 column is catastrophic for all scenarios except Scenario 7, confirming the NV would never over-order in a deterministic setting.
RS Perspective
RS profit increases monotonically with order size S — more NV orders means more RS earns:
RS Profit = S × ₹5 − ₹1,50,000
Order Level RS Outcome S < 30,000 RS always makes a loss — fixed cost not covered S = 30,000 RS exactly breaks even — no profit incentive to participate S > 30,000 Each additional unit earns ₹5 contribution margin → profitable and growing
RS rational behaviour: Refuse to supply if expected order S < 30,000 units — the order is simply not commercially viable.
RS payoff depends only on S (not on D directly — RS cannot observe demand):
Scenario Demand S=0 S=1,000 S=2,000 S=10,000 S=20,000 S=30,000 S=40,000 S=5,00,000 All scenarios Any 0 −1,45,000 −1,40,000 −1,00,000 −50,000 ₹0 +50,000 +23,50,000
Critical observation: RS payoff is identical across all demand scenarios for a given order size S — because RS profit depends only on the quantity ordered, not on what the market demand actually is. The RS never sees demand; it only sees S.
This is the asymmetry: NV’s profit varies with D, RS’s profit does not — yet D determines what S the NV will place. RS is entirely dependent on NV’s market knowledge.
Demand Level NV’s Rational Order NV Outcome RS Outcome SC Result D < 30,000 (S1–S4)S* = D < 30,000 Profitable ✓ Loss up to −₹1,40,000 → RS refuses to supply SC collapses ✗ D = 30,000 (S5)S* = 30,000 +₹3,00,000 ✓ ₹0 exactly — no profit motive RS may refuse ⚠ D ≥ 40,000 (S6, S7)S* = D ≥ 40,000 Profitable ✓ Profitable ✓ SC works ✓
Could NV make RS profitable by ordering ≥ 30,000 when D < 30,000? Yes — but NV would then incur a massive loss (e.g., Scenario 2: NV orders 40,000 when D = 2,000 → NV loss = −₹3,60,000). NV will never voluntarily do this.
This is the core tension: the action that saves the RS destroys the NV. No voluntary coordination is possible without an external mechanism.
SC = NV Profit + RS Profit
SC total payoff = NV profit + RS profit for each order size S and demand level D.
Scenario Demand S=0 S=1,000 S=2,000 S=10,000 S=20,000 S=30,000 S=40,000 S=5,00,000 1 0 0 −1,55,000 −1,60,000 −2,00,000 −2,50,000 −3,00,000 −3,50,000 −26,50,000 2–4 2,000 0 −1,35,000 −1,20,000 −1,60,000 −2,10,000 −2,60,000 −3,10,000 −26,10,000 5 30,000 0 −1,35,000 −1,20,000 0 +1,50,000 +3,00,000 +2,50,000 −20,50,000 6 40,000 0 −1,35,000 −1,20,000 0 +1,50,000 +3,00,000 +4,50,000 −18,50,000 7 5,00,000 0 −1,35,000 −1,20,000 0 +1,50,000 +3,00,000 +4,50,000 +73,50,000
Key SC finding: When NV orders S* = D, the SC total payoff is:
Scenario at S* = D NV Profit RS Profit SC Total SC Viable? S1–S4 (D = 2,000) +₹20,000 −₹1,40,000 −₹1,20,000 No ✗ S5 (D = 30,000) +₹3,00,000 ₹0 +₹3,00,000 Barely S6 (D = 40,000) +₹4,00,000 +₹50,000 +₹4,50,000 Yes ✓ S7 (D = 5,00,000) Maximum Maximum Maximum Yes ✓
★ Key finding: NV’s best decision (S* = D) is also the best possible decision for the total SC — but only when D ≥ 30,000 . When D < 30,000, even the SC-optimal order (S* = D) results in a net SC loss because RS’s fixed costs cannot be recovered.
Scenario Demand NV’s S* NV Profit RS Profit SC Total RS Engage? 1 0 0 ₹0 ₹0 (or −₹1,50,000 if operating) ₹0 Not needed 2–4 2,000 2,000 +₹20,000 ✓ −₹1,40,000 ✗ −₹1,20,000 ✗ No ✗ 5 30,000 30,000 +₹3,00,000 ✓ ₹0 (breakeven) +₹3,00,000 Maybe ⚠ 6 40,000 40,000 +₹4,00,000 ✓ +₹50,000 ✓ +₹4,50,000 ✓ Yes ✓ 7 5,00,000 5,00,000 Maximum ✓ Maximum ✓ Maximum ✓ Yes ✓
Player Preferred Order Size Why Conflict? News Vendor S* = D (match demand exactly) Overstocking wastes procurement budget. Understocking wastes revenue opportunity. — Regional Supplier S as large as possible (> 30,000) Fixed cost of ₹1,50,000 must be covered. Marginal profit = ₹5/unit — more units = more profit. YES ✗ — NV caps order at DSupply Chain (Total) S* = D (same as NV when D ≥ 30,000) When D ≥ 30,000 and NV orders = D, total SC profit is maximised and both players are profitable. No conflict (when D ≥ 30,000)
Always: S* = D — profit is highest, risk is lowest.
The NV will never rationally deviate from this rule in the deterministic setting. At every demand level, ordering exactly D dominates all other options on both sides.
RS wants the largest possible order size — but cannot control it . The NV decides S unilaterally based on demand knowledge that RS does not have.
For D < 30,000: RS refuses to engage → SC collapsesFor D = 30,000: RS breaks even → barely participatesFor D ≥ 40,000: RS is profitable — but still wishes NV would order even more Scenarios where RS is profitable but NV is not (e.g., S = 40,000 when D = 2,000) will never occur — the NV is rational and will never voluntarily accept a loss to benefit the RS.
NV’s best = SC’s best ONLY when D ≥ 30,000 and NV matches demand.
When D < 30,000: NV’s optimal order is also the best achievable for the SC — but it still results in an SC loss because RS cannot cover fixed costs and will refuse to participate.
★ Decentralised SC = SC performs well only when market demand is sufficiently large to make both players naturally profitable.
For the SC to function when D < 30,000, the NV must be incentivised to deviate from S* = D — to order more than demand dictates, making RS viable, even when doing so hurts the NV individually.
Identify the gap: NV orders S* = D < 30,000 → RS unviable → SC collapsesDesign a coordination contract: Restructure payoffs so NV gains by ordering more than DContract options:
Buyback contract: RS agrees to buy back unsold units from NV → NV’s overstocking risk is reduced → NV willing to order moreRevenue sharing contract: NV shares a portion of sales revenue with RS → RS reduces wholesale price → NV orders more → both benefitQuantity flexibility contract: RS commits to accepting returns up to a percentage of the order → NV’s downside risk capped
Platform economy connection: Platforms reduce information asymmetry and can enforce coordination contracts digitally — covered in upcoming sessions
Setting Key Difference NV’s Challenge Deterministic (this session) D is known before S is chosen NV always orders S* = D perfectly — no uncertainty Probabilistic (next session) D is unknown when S must be decided NV must choose S before knowing actual demand → risk of over or understocking
In the probabilistic setting, the same SC conflict appears — but now with an additional layer of demand uncertainty. The NV can no longer simply match demand; it must balance:
Overage cost: Cost of procuring units that go unsoldUnderage cost: Cost of lost sales when demand exceeds the order The optimal S* is no longer simply D. It depends on the probability distribution of demand and the relative magnitude of overage vs. underage costs.
Element Key Result NV payoff curve Inverted-U shape, peaking at S* = D for every demand level NV dominant strategy Always order exactly S* = D — no rational deviation in deterministic setting RS payoff rule Profits only when S > 30,000. NV’s best order may not satisfy this → RS refuses SC total payoff NV’s best = SC’s best when D ≥ 30,000. SC total loss when D < 30,000. Root conflict NV wants S = D. RS wants S as large as possible. These clash when D < 30,000. Coordination needed When D < 30,000 — NV must be incentivised (via buyback/revenue sharing/quantity flexibility) to order beyond demand Next session Probabilistic demand setting — same conflict + demand uncertainty → cost trade-off formula for optimal S*