  Unlike consumer goods industry, a high-tech manufacturer (OEM) often
amortizes new product development costs over multiple generations, where demand
for each generation is based on advance orders and additional uncertain demand.
Also, due to economic reasons and regulations, high-tech OEMs usually source
from a single supplier. Relative to the high retail price, the wholesale price
for a supplier to produce high-tech components is low. Consequently, incentives
are misaligned: the OEM faces relatively high under-stock costs and the
supplier faces high over-stock costs. In this paper, we examine supply
contracts that are intended to align the incentives between a high-tech OEM and
a supplier so that the supplier will invest adequate and yet non-verifiable
capacity to meet the OEM's uncertain demand. When focusing on a single
generation, the manufacturer can coordinate a decentralized supply chain and
extract all surplus by augmenting a traditional wholesale price contract with a
"contingent penalty" should the supplier fail to fulfill the OEM's demand. When
the resulting penalty is too high to be enforceable, we consider a new class of
"contingent renewal" wholesale price contracts with a stipulation: the OEM will
renew the contract with the incumbent supplier for the next generation only
when the supplier can fulfill the demand for the current generation. By using
non-renewal as an implicit penalty, we show that the contingent renewal
contract can coordinate the supply chain. While the OEM can capture the bulk of
the supply chain profit, this innovative contract cannot enable the OEM to
extract the entire surplus.
