Supply Chain Contracts have been reasonably well documented in academic literature. Some of them are also well understood and implemented too by large companies in some form or fashion. From as basic as VMI agreements, price contracts, value contracts, volume contracts, capacity contracts etc. to as advanced as revenue sharing contracts and buy back contracts.
But these agreements address only systemic risks. The risks which are partly under the control or the buyer-seller system. A risk that manifests from divergence in business as usual. Demand x Supply. e.g. standard deviation, forecast errors etc.
Weather Rebate Contracts are a class of rebate agreements that are not entirely systematic. One party loses a lot more because of weather risk. esp. the Retailer. The idea behind these types of contracts is to minimize the risk of the retailer esp. for products whose demand is weather sensitive. And more so for products with little of no salving value. E.g. Perishables. If the weather is not as predicted, the retailer can lose a lot of money. Inventory surplus that cannot be sold.
One alternative here is to pass on the weather risk to a third-party company who can engineer a financial derivative to absorb this risk at a premium. Just like an insurance premium. These types of contracts are typically not very common. Financial Institutions do offer some ‘supply chain financing’ solutions as they typically tend to have much stronger capabilities of modeling risk.
The other alternative is to craft a weather rebate contract. Between the supplier and the retailer. These contracts use concepts like Strike Quantity, Strike Price and Cooling Day Degrees. The idea here to minimize the risk of the retailer who is at greater exposure to weather risk. E.g. Ice-creams and Wollens. The ‘model’ here uses the concept of Conditional Value at Risk (CVaR).
To know more about how to implement weather rebate agreements, connect with ARIJIT DUTTA who loves talking about advanced topics in supply chain management and operations in general.
