Long-Term Contracts to Support Upstream Manufacturers in Scaling up Low-Carbon Production

To reduce Scope 3 emissions which largely originate from upstream manufacturing of products, including components and materials, brand firms are increasingly sourcing products produced using clean energy in their production processes. Despite this trend, manufacturers face practical challenges: purchasing green electricity incurs variable costs that reduce per-unit profits and may limit production expansion, whereas on-site renewable generation involves fixed costs and necessitates securing sufficient long-term orders to cover these costs. To support low-carbon production, brand firms such as Apple form long-term partnerships with key manufacturers. This study extends research on long-term wholesale price contracts (LT contracts) for green purchasing and relational contracts (RT contracts) for green supplier development, examining how these contracts coordinate a decentralized supply chain comprising two substitutable manufacturers, each using different clean energy portfolios and exhibiting heterogeneous fixed and variable costs. A LT contract offers a consistent wholesale price, while an RT contract involves an initial transfer payment and order-related payments. Both contract types aim to maximize a combined objective of profit and carbon reduction for a buyer under a repeated newsvendor setting. A manufacturer can secure orders by increasing fixed-cost investments when its variable cost is relatively high compared to the other manufacturer. This study also provides practical insights for the buyer seeking to generalize Apple's approach through simple, implementable long-term contracts. LT contracts increase the engaged manufacturer's production quantity relative to the short-term wholesale price (ST) contract while offering a lower wholesale price, yet they fail to achieve the first-best production level. In contrast, RT contracts align the engaged manufacturer's profits with its fixed-cost investment, enabling supply chain coordination and further incentivizing the manufacturer to enhance fixed-cost investments.