Abstract: Product safety issues caused by low-quality products have become a major issue in supply chain operation management. Product safety incidents have been frequent in recent years. For example, in 2006, Dell recalled nearly 4.1 million Sony Corp notebook computer batteries that could catch fire, costing Dell more than 400 million dollars. In 2007, Tesla was forced to recall more than 50,000 Model X vehicles due to a faulty design in its supplier BremboSpA’s parking brake system. This recall has also resulted in a huge loss in Tesla’s market value. These cases reveal that a downstream firm that dominates the supply chain often bears product liability for product safety events caused by quality defects in a component made by its upstream suppliers. Therefore, it has become a crucial problem for the core downstream firm in the supply chain to design an effective incentive contract to motivate upstream suppliers to improve the quality level and reduce the increased liability costs.

Key words: supply chain; product liability; quality; cost sharing