Procurement Mechanism Design in a Two-Echelon Inventory System with Price-Sensitive Demand

We study a retailer’s sourcing contract when the supplier’s reservation profit (offered by his outside options) depends on his cost, which is privately known to only the supplier. An interesting discovery from our analysis is that supply chain coordination may be achieved despite the information asymmetry between the two firms regarding the supplier’s type (i.e., his cost). This happens when the marginal contribution of the supplier’s cost efficiency to the trade matches with the supplier’s marginal reservation profit. In this case, the optimal contract quantities maximize the supply chain profits for the respective supplier types, and no information rent is paid to any supplier type. For the general case, we show that, regardless of his type, the supplier may have an incentive to overstate or understate his cost, depending on whether or not his marginal contribution to the trade exceeds his marginal reservation profit. We demonstrate six possible forms of the optimal contract. Observations from our analysis contrast with those derived from previous studies, complementing the theory of countervailing incentives.

Section: Related Literaturesupporting

confidence: 92%

Sourcing Contract under Countervailing Incentives

Gan

Feng

Sethi

2019

“…There is a stream of research that studies contracting problems under asymmetric cost information in supply chain settings. The representative studies include, for example, Corbett and de Groote (2000), Corbett (2001), Ha (2001), Corbett et al (2004), Cachon and Zhang (2006), Zhang (2010), € Ozer and Raz (2011), Bolandifar et al (2018), and Hu and Qi (2018). Most of these studies focus on screening models where the uninformed player moves first by offering a menu of contracts to elicit the informed player's private cost information.…”

Section: Literature Reviewmentioning

confidence: 99%

Sourcing Competition under Cost Uncertainty and Information Asymmetry

Shao

Zhang

2020

Self Cite

Driven by increasing costs in the traditionally regarded low‐cost manufacturing bases (e.g., China), many firms have started to outsource their production to the regions of even lower costs (e.g., Southeast Asia). However, a new environment may involve higher cost uncertainty and severer information asymmetry. Motivated by these observations, we consider a sourcing game where competing firms choose between a supplier with transparent certain cost (type‐C supplier) and a supplier with potentially lower but less transparent, uncertain cost (type‐U supplier). We characterize the equilibrium of the sourcing game and study how different parameters affect the firms’ sourcing strategy and profit performance. First, we find that due to information asymmetry, a large market size can make firms prefer the C‐supplier to the U‐supplier even if the latter has a lower average cost. Second, reducing the cost uncertainty or improving the signal accuracy of the U‐supplier does not necessarily make it more attractive to sourcing firms, which cautions the suppliers when making efforts to mitigate cost uncertainty or improve cost estimation. Third, higher competition intensity makes the diversified sourcing strategy more likely to be adopted under certain conditions. Interestingly, increasing the cost of the C‐supplier (e.g., a cost hike in China) may make both sourcing firms better off because it can lead to a new sourcing equilibrium. Finally, this study shows that the direction of quantity distortion under the optimal competitive mechanism differs from that under the traditional monopolistic setting.

“…A key finding is that linear contracts can perform well compared to the optimal mechanism. In the operations management literature, several papers explicitly investigate the performance of simple procurement contracts, including Cachon and Zhang (2006), Zhang (2010), Duenyas et al (2013), Kayis et al (2013), and Bolandifar et al (2018). Our study differs from the above papers in two important ways: First, we model correlated asymmetric information on quality and capacity costs in a service setting with queueing features; second, we show that the performance of simple contracts depends on the correlation of the costs, that is, simple contracts may not perform well especially under negative correlation between the capacity and quality costs.…”

Section: Literature Reviewmentioning

confidence: 99%

Service Outsourcing: Capacity, Quality and Correlated Costs

Feng

Ren

Zhang

2019

Self Cite

This paper studies how to design service outsourcing contracts to ensure fast, quality services from an independent service provider. The outsourcer does not have perfect information about the service provider’s capacity cost (i.e., cost of providing fast service) and quality cost (i.e., cost of achieving a high quality level). Moreover, the two unknown costs may be positively, or negatively, correlated with each other. We solve for the outsourcer’s optimal outsourcing contract, and show that the structure of the optimal contract depends on the relationship between the costs. Specifically, we highlight the following observations when the two costs are negatively correlated: First, under certain conditions, the outsourcer may be able to squeeze the supplier’s profit (information rent) to zero for an intermediate range of cost realizations; second, it is possible that the service supply chain is coordinated by using the outsourcer’s optimal contract. We then examine the performance of two classes of commonly observed contracts that are relatively simple to implement. It has been found that these simple contracts generally perform well when the costs are positively correlated, but they could perform much worse when the costs are negatively correlated. Our results therefore caution outsourcing companies that the potential trade‐off between capacity cost and quality cost may require a careful design of outsourcing contracts.