Why are minimum order quantity contracts popular in practice? a behavioral investigation

Problem Definition In theory, all coordinating contracts are equivalent, however, the minimum order quantity (MOQ) is observed to be more popular in practice. We seek to understand whether the differences in complexity across the different coordinating contracts can explain why.

Academic/Practical Relevance The behavioral operations management literature has established a tradeoff between complex coordinating and simple non-coordinating contracts. This paper fills a gap in the literature by studying whether the coordinating MOQ contract attenuates this tradeoff. We also study if it is indeed the preferred contract when subjects are allowed to choose among coordinating contracts.

Methodology First, we introduce a novel experimental design where, in each period, subjects in the role of suppliers can choose both the type of contract to offer and the parameters of that contract. In subsequent treatments, we test whether subjects given only a single contract type can optimize its parameters. In a final set of treatments, we repeat all previous treatments with a decision support tool designed to lessen complexity.

Results We find that (i) subjects choose the MOQ contract more frequently over theoretically equivalent coordinating contracts; (ii) subjects perform significantly better with the MOQ contract compared to other coordinating contracts, and; (iii) this can be attributed to lower cognitive burden induced by the MOQ contract.

Managerial Implications We show that the tradeoff between efficiency and complexity can be mitigated by simpler yet efficient contracts. Investing in decision support systems can also mitigate this tradeoff, but doing so might be is prohibitively costly for smaller firms and firms based in emerging or underdeveloped markets. Hence, there is considerable benefit to identifying contractual mechanisms that ameliorate the adverse effects of complexity.