Design and analysis of optimal incentive contracts between fourth-party and third-party logistics providers

Abstract

Recent development in logistics has led to wide use of fourth-party logistics (4PL) and third-party logistics (3PL) service providers. Given the increase of the supply chain complexity and growth of intense competition, these logistics service providers (LSPs) face increasing challenges. A viable way is to cooperate. This paper aims to apply the principal-agent theory to the logistics industry by studying the horizontal cooperation between 4PL and 3PL providers through the use of incentive contracts. In contrast with traditional economic literature, compensation in this case is a combination of a fixed payment and a bonus based on the performances of the 3PL providers, in terms of service delivery rate and customer satisfaction level, which are industry specific. The problem is modeled as a risk-neutral 4PL provider hires multiple riskaverse 3PL providers to conduct different logistics tasks involved in a project. The goal of this paper is to study the design of optimal contracts that balance the incentives and risks of the 3PL providers from the perspectives of 4PL provider, so that both them can achieve maximized profits.