Input material reduction incentives versus scrap recycling for closed‐loop supply chains

Motivated by interactions with a major player in the aerospace industry, we consider the relationship between a supplier of specialty material forgings and a buyer that manufactures airplane components by extensively machining down these forgings as per component design specifications. Due to high material removal costs, the buyer prefers these forgings to be as similar in geometry and size to the component as possible, that is, near‐net‐shape. The supplier, by default, is unable to deliver such near‐net‐shape forgings as per technological constraints, but can utilize costly effort and/or invest in the required technologies to achieve such capabilities. By taking into account uncertainty regarding the correspondence between supplier's effort and resulting forging size, we assess the implications of two innovative approaches for improving supply chain performance: (i) input material reduction incentives via contracting and (ii) scrap material recycling. We characterize the optimal decisions with respect to final component geometry, various costs, and which party in the supply chain controls the strategic recycling decision. We find that the supply chain should utilize both approaches in a complementary way for components with complex geometry, yet deliberately limit recycling and eliminate contracting for components with simple geometry—a strategy the buyer always implements when controlling the recycling decision. Furthermore, we show these contracting and recycling strategies to be robust by considering linear, expected cost sharing, and nonlinear contract alternatives. Finally, we study supply chain inefficiencies that result from decentralizing the recycling and/or contracting decisions, and highlight whether expected cost sharing and nonlinear contracts can outperform linear contracts.