An Experimental Investigation of Managing Quality Through Monetary and Relational Incentives

Abstract

We investigate the efficacy of monetary and relational incentives for managing the quality of a product in a two-tier supply chain. In our setting, a retailer offers a supplier contract terms for a product, where the product can be low or high quality. The supplier can choose to exert high effort, which is costly but guarantees high quality, or low effort, which does not assure high quality with certainty. We compare how monetary incentives, such as a bonus that is paid to the supplier when high quality is received by the retailer, and relational incentives, such as the two parties engaging in a long-term relationship where there is the threat of punishment, affect overall quality and supply chain efficiency. Two of our primary results suggest that (1) relational incentives improve both quality and supply chain efficiency, regardless of whether a monetary incentive is present, and (2) when relational incentives are present, the impact of adding monetary incentives is nonmonotonic: less efficient monetary incentives appear to crowd out the benefits of relational incentives leading even to a reduction in supply chain efficiency, whereas more efficient monetary incentives actually complement relational incentives and lead to significant increases in both quality and supply chain efficiency. We then proceed by demonstrating that a behavioral model of fairness can organize the data quite well.

Behavioral Operations and Supply Chain Management–A Review and Literature Mapping

“…In the most recent studies, Abbey, Kleber, Souza, and Voigt () and Agrawal, Atasu, and Van Ittersum () use both a survey and experiments to investigate consumers’ perception of quality for remanufactured products and factors affecting their willingness to pay for them. Davis and Hyndman () focus on the role of relational and/or monetary incentives on supply quality and supply chain efficiency. Ren, Huang, and Arifoglu () consider bounded rationality of customers in perceiving quality of services and characterize the service provider's decision of quality, pricing, control, and information disclosure.…”

Quality Management by Warranty Contract Under Dual Asymmetric Information

“…[17] evaluated the relationship between hard and soft quality management and organisational context. [18] experimentally investigated how the monetary and relational incentives may affect the overall quality and supply chain efficiency in a two-tier supply chain. [19] tested how the buyer may manage the sourced quality by three instruments: investment, incentives, and inspection.…”

Trust and Trustworthiness in Procurement Contracts with Retainage

“…We fit our behavioral model to the data and provide a characterization of the optimal retainage level, given beliefs about the fair reference point in the transaction. By doing so, we contribute to a growing behavioral operations literature addressing how social preferences influence supply chain contracting (Beer et al 2018, Cui et al 2007, Hu et al 2017, Katok and Pavlov 2013, Loch and Wu 2008 Closely related, but in a non-competitive setting, Davis and Hyndman (2018) find that monetary incentives may complement relational incentives when efficiency of the monetary incentive is high, but crowd out relational incentives when it is low. Also related, Li et al (2020) observe that a target-based bonus contract induces significantly higher effort by store managers in an inventory context, but that fairness concerns undermine its effectiveness.…”