To Collaborate or Not to Collaborate: Prompting Upstream Eco-efficient Innovation in a Supply Chain

Large retailers are a source of great stress for suppliers in supply chains: they want better environmental performance and ever-lower prices without sacrificing product quality. Retailers’ initiatives pressure suppliers to invest substantially upfront to reduce packaging and energy use. The potential savings in packaging materials, production and shipping costs that could offset suppliers’ upfront investments, however, are not going mainly toward suppliers’ bottom lines, since the retailers appear to share only the savings but not the upfront investment. Thus, retailers’ heralded sustainability initiatives are weighed down by the substantial costs to be borne by suppliers alone, and retailers’ efforts to improve the environmental performance of their supply chains do not materialize as predicted. In this paper, we consider a two-echelon supply chain where an upstream supplier sells through a downstream retailer. The supplier is accountable to invest effort in an eco-efficient innovation, which decreases her unit production cost while improving the per-unit environmental performance of her product and increases the value of the product to consumers (so enhancing market demand), and the retailer who embodies the channel power sets the product price and sells to consumers. First, we delve into the non-collaborative case where the retailer imposes a minimum requirement on the level of eco-efficient innovation effort to be invested by supplier. Second, we study the profit/cost implications of collaboration between two parties for upstream eco-efficient innovation by scrutinizing two types of contracts: a cost-sharing agreement wherein the retailer shares a fraction of the supplier's upfront cost of investment in innovation; and a revenue-sharing agreement under which the retailer shares a fraction of his revenues generated by the supplier's eco-efficient innovation effort. For each contract, we also contemplate the possibility of negotiation between the retailer and supplier which forms the basis of division of costs and revenues under a cost- and revenue-sharing contract, respectively.