Using a Dual-Sourcing Option in the Presence of Asymmetric Information About Supplier Reliability: Competition vs. Diversification

Abstract

We study a buyer's strategic use of a dual-sourcing option when facing suppliers possessing private information about their disruption likelihood. We solve for the buyer's optimal procurement contract. We show that the optimal contract can be interpreted as the buyer choosing between diversification and competition benefits. Better information increases diversification benefits and decreases competition benefits. Therefore, with better information the buyer is more inclined to diversify. Moreover, better information may increase or decrease the value of the dual-sourcing option, depending on the buyer's unit revenue: for large revenue, the buyer uses the dual sourcing option for diversification, the benefits of which increase with information; for small revenue, the buyer uses the dual sourcing option for competition, the benefits of which decrease with information. Surprisingly, as the reliability of the entire supply base decreases, the buyer may stop diversifying under asymmetric information (to leverage competition), whereas it would never do so under symmetric information. Finally, we analyze the effect of codependence between supply disruptions. We find that lower codependence leads the buyer to rely less on competition. Because competition keeps the information costs in check, a reduction in supplier codependence increases the buyer's value of information. Therefore, strategic actions to reduce codependence between supplier disruptions should not be seen as a substitute for learning about suppliers' reliabilities.

Incentives for quality improvement efforts coordination in supply chains with partial cost allocation contract

“…Yang et al (2012) propose a dual-sourcing option to decrease supply risk when suppliers face the possibility of disruption. An optimal procurement contract provides the manufacturer with the opportunity of choosing between diversification and competition advantage.…”

Maverick buying: Eliminate, participate, leverage?

“…The principal acknowledges the outside option and re-evaluates the budgets. Similar to Yang et al (2012) and Li (2013) who apply mechanism design to capture the outcome of a negotiation between a buyer and its supplier, our participation menus can be interpreted as a negotiation between the central purchasing department and its local counterpart. In practice, the negotiations allow the principal and the agent to exchange information, resulting in different outcomes depending on whether the agent chooses the frame contract or has an attractive outside option.…”

Split-Award Auctions for Supplier Retention

“…Multisourcing has typically been analyzed in the procurement literature as a means to manage situations where suppliers may fail to deliver the units they are assigned to produce. For example, Kleindorfer and Saad (2005), Tomlin (2006), and Federgruen and Yang (2009) discuss supply risk mitigation through multisourcing; Babich et al (2007), Yang et al (2012), and Chaturvedi and Martínez-de-Albéniz (2011) consider supply diversification to mitigate supply disruption risk under information asymmetry. In our setting, we also multisource, but for an entirely different reason.…”