Supply Disruptions, Asymmetric Information and a Backup Production Option

Abstract

We study a manufacturer that faces a supplier privileged with private information about supply disruptions. We investigate how risk-management strategies of the manufacturer change, and examine whether risk-management tools are more, or less, valuable, in the presence of such asymmetric information. We model a supply chain with one manufacturer and one supplier, in which the supplier's reliability is either high or low and is the supplier's private information. Upon disruption the supplier chooses between paying a penalty to the manufacturer for the shortfall and using backup production to fill the manufacturer's order. Using mechanism design theory, we derive the optimal contract menu offered by the manufacturer. We find that information asymmetry may cause the less reliable supplier type to stop using backup production while the more reliable supplier type continues to use it. Additionally, the manufacturer may stop ordering from the less reliable supplier type altogether. The value of supplier backup production for the manufacturer is not necessarily larger under symmetric information and, for the more reliable supplier type, it could be negative. The manufacturer is willing to pay the most for information when supplier backup production is moderately expensive. The value of information may increase as supplier types become uniformly more reliable. Thus, higher reliability need not be a substitute for better information.

Managing product quality risk and visibility in multi-layer supply chain

“…Yang et al (2009) had grouped the tools for managing supply chain risk into four main themes: multi-sourcing (e.g., Anupindi and Akella, 1993;Babich et al, 2005Babich et al, , 2007, alternative supply sources and backup production (e.g., Serel et al, 2001;Kouvelis and Milner, 2002), flexibility (e.g., Van Mieghem, 2003;Tomlin and Wang, 2005) and supplier selection (e.g., Deng and Elmaghraby, 2005). On the other hand, Microsoft and Arthur Anderson developed a supply risk assessment process-Comprehensive Outsource Risk Evaluation (CORE) system in which Risk is analyzed ''objectively''.…”

“…This example illustrates that, as supply chains are extended by outsourcing and stretched by globalization, disruption risks and lack of visibility into a supplier's status can both worsen (Yang et al, 2009). It is very hard for firms to manage the visibility of a long or ''deep'' supply chain which has a low traceability of material origin.…”

“…A manufacturer has a number of risk management strategies when managing supply quality risk, including supplier qualification screening, multi-sourcing, flexibility, and penalties levied for supplier non-performance (Yang et al, 2009). Some researches focus on contract designing issue for obtaining the equilibrium outcome that the penalty clauses are adopted as recover damage in non-delivery (Baiman et al, 2000;Yang et al, 2009), or base on the information from the incoming inspection and the external failure (Balachandran and Radhakrishnan, 2005).…”

“…Some researches focus on contract designing issue for obtaining the equilibrium outcome that the penalty clauses are adopted as recover damage in non-delivery (Baiman et al, 2000;Yang et al, 2009), or base on the information from the incoming inspection and the external failure (Balachandran and Radhakrishnan, 2005). Intuitively, the effectiveness of supply chain risk management strategies depends on visibility among supply chain members and the manufacturer.…”

“…The majority of recent papers treated the product quality problem as production quality problem (Tannock and Balogun, 2007;Karim et al, 2008;Halesand and Chakravorty, 2006) and supply chain risk management mainly focused on supply chain disruption (Yang et al, 2009;Baiman et al, 2000;Tomlin, 2006). Hwang et al (2006) examined the arrangement of vendor certification and appraisal in mitigating the problem of supplier quality, but they looked into the problem in inspection strategies and there was nothing much related to the sourcing strategies in supply network.…”