5/21/18 Quality at the Source or at the End? Managing Supplier Quality Under Information Asymmetry Mohammad Nikoofal Ted Rogers School of Management Ryerson University, Toronto, Canada Mehmet Gumus Desautels Faculty of Management McGill University, Montreal, Canada Ferdowsi University of Mashhad Department of Industrial Engineering Agenda Ø Contract manufacturing: Pros vs. Cons Ø Informational issues in contract manufacturing Ø The importance of adverse selection and moral hazard in manufacturing è Research Questions Ø Model development and analysis Ø Managerial Insights 2 1
5/21/18 Contract Manufacturing as a Business Model Innovation $245 $278 Contract Manufacturing: Real World Motivations Ø In a contract manufacturing business model, a buyer contracts with a supplier for manufacturing of some components of product or whole product. Ø It becomes a dominant business model*: § Of $1 trillion manufacturing market, $300 billion is outsourced to contract manufacturers. § Less than 25% of an automobile is manufactured by the automaker. § In the case of many innovative products, more than 85% of the manufacturing is outsourced to CMs. 4 * Supply Chain Brutalization (The handbook of Contract Manufacturing) by “Walt Grischuk” 2
5/21/18 Contract Manufacturing: Pros vs. Cons Benefits Risks 5 Lack of Control/Visibility over Supplier Tops the List Ø What are the greatest obstacles to improving supply-chain risk management at your company*? 1. Lack of control/visibility over suppliers’ risk management practices 2. Lack of time and resources 3. Lack of tools, frameworks, and decision-making structures for supply-chain risk management 6 * Physical risks to the supply chain: the view from finance ; CFO Publishing Corp , 2009 3
5/21/18 Two-dimensional Visibility Risk 1. Visibility over the “ conditions” under which the contract manufacturer is working (e.g., operational capability, level of experience in production planning, supplier’s flexibility): Adverse Selection Ø Philips had better understanding about the consequences of lightning storm than Nokia & Ericsson Ø Japanese car firms weekly shutdowns due to power shortage in 2011 after Tsunami in Japan 2. Visibility over the “ actions” that contract manufacturer takes: Ø Dozens of deaths from the blood thinner Heparin Moral Hazard Ø Toyota audit finds misunderstanding with suppliers 7 Toyota Audit Finds “Misunderstanding” with Suppliers Ø Recalling 8 million vehicles around the world due to the malfunctioning gas pedals in 2009-2010 Ø Toyota sent the auditors to its most trusted suppliers Ø A surprising result for Toyota: Instead of testing parts four times a year, these highly trusted suppliers were testing them only once every year! 8 4
5/21/18 Two Contracts to Deal with Visibility Issues Ø Dealing with lack of information in the supply chain, firms use contract manufacturers to inspect their suppliers’ end-products and their production- related decisions and link their incentives to the outcomes of these inspections . Ø There are two types of inspections: 1. Those that test whether the quality of the final output conforms to the standards prespecified by the manufacturer Ø We call it Quality at-the-End (QE) contract Payment is contingent on the end product’s quality Ø 2. Those that test the suppliers’ actions that affect the quality of the final product Ø We call it Quality-at-the-Source (QS) contract Payment is released to the supplier based on the actual quality-effort decision Ø made at source The Supply Chain Model Reliable supplier ( 𝒊 -type, 𝜾 = 𝒊 ) 𝝃 ) 𝒊 𝝑{𝟏, 𝟐} 𝒓 Manufacturer Supplier 𝟐 − 𝝃 Unreliable supplier ( 𝒎 -type, 𝜾 = 𝒎 ) 𝒓 ) 𝒎 𝝑{𝟏, 𝟐} 1. Given 𝑓 0 = 𝑓 1 = 𝑓 ∈ 0,1 è 𝑞 0 𝑓 ≥ 𝑞 1 𝑓 2. For 𝜄 -type supplier where 𝜄 ∈ ℎ, 𝑚 : 𝑞 : 𝑓 : = 1 ≥ 𝑞 : 𝑓 : = 0 10 5
5/21/18 Timing of Events and Decisions Contracting stage Improvement stage Execution stage Under “QE” contract, the Under “QS” contract, the manufacturer decides Manufacturer Supplier picks a manufacturer decides whether or whether or not to inspect chooses between contract and receives not to audit the supplier ’s effort the quality of outcome and “QE” and “QS” upfront payment 𝜕 : and pays 𝑍 : only if 𝑓 : = 𝐹 : pays 𝑍 : only if 𝑟 ? = 1 Time Manufacturer offers a menu of Supplier decides on Supplier runs Supplier observes the contracts: 𝜕 : , 𝑍 : under “QE” quality improvement production, and the state of his reliability contract, and 𝜕 : , 𝑍 : , 𝐹 : under effort 𝑓 : ∈ 0,1 outcome 𝑟 ? : is realized type, 𝜄 ∈ 𝑚, ℎ “QS” contract 𝝏 𝜾 : payable by the manufacturer to the supplier upon the supplier’s participation QE è payable to the supplier if quality inspection confirms that the quality of the product is acceptable 𝒁 𝜾 QS è payable to the supplier if audit reports that 𝒇 𝜾 = 𝑭 𝜾 Research Questions Research Question 1: What is the impact of the optimal QE and QS contracts on the incentives of the manufacturer and the supplier as well as the reliability of the entire supply chain? Research Question 2: Which one of the above incentive and inspection mechanisms should be employed by a manufacturer in dealing with a risky supplier? Research Question 3: How does asymmetric information affect the value of each contracting strategy from the perspective of each of the individual supply chain parties as well as the supply chain as a whole? 12 6
5/21/18 Complete Information (First-Best) Scenario Ø As a benchmark, suppose that both manufacturer and supplier work together as an integrated firm . Ø Let “fb” indicate the first-best level of improvement effort. Ø The integrated firm’s optimization problem is to find the optimal level EF ∈ 0,1 . of improvement efforts 𝑓 : 𝐠𝐜 = 𝟐 è 𝒒 𝜾 𝟐 𝒔 − 𝒅 − 𝑫 𝒓 𝐠𝐜 = 𝟏 è 𝒒 𝜾 𝟏 𝒔 − 𝒅 If 𝒇 𝜾 If 𝒇 𝜾 VS. Ø Under the first-best outcome, the integrated firm invests in quality EF = 1 , if 𝐷 H ≤ 𝑞 : 1 − 𝑞 : 0 𝑠 . improvement efforts, i.e., 𝑓 : Quality at-the-End (QE) Contract Ø After production is complete, the manufacturer decides whether to perform a quality inspection test 𝑈 = 1 (at the cost of 𝜔 S ) or not 𝑈 = 0 . Ø Contingent payment 𝑍 : : 𝑈 = 1 : if the production outcomes pass the test (i.e., 𝑟 ? : = 1 ). § 𝑈 = 0 : payable irrespective of the quality of production outcomes. § Ø Degree of “inaccuracy” of the test: 𝜈 S = Pr Test report non−defective ∣ 𝑟 ? : = 0 . Quality Inspection Game 𝜷 𝜾 𝟐 − 𝜷 𝜾 𝜸 𝜾 𝟐 − 𝜸 𝜾 7
5/21/18 Analysis of Quality Cost of quality test for Inspection Game manufacturer # $ Region IV – Pure strategy: Ø After we characterize all the Manufacturer stops inspection, and supplier stops exerting effort Nash equilibria of the ' ( , * ( = 0,0 inspection subgame, the & $ # next step is to find the Region II – Mixed strategy: optimal QE contract that Manufacturer performs inspection with probability ' ( ∈ 0,1 , and % -type would induce each Nash supplier exerts effort with probability equilibrium . * ( ∈ 0,1 Region III – Pure strategy: Manufacturer inspects, and # $ Ø Because there are 4 supplier stops exerting effort ' ( , * ( = 1,0 different equilibria, we Region I – Pure strategy: Manufacturer inspects, need to solve 4 different and supplier exerts effort ' ( , * ( = 1,1 optimal contract optimization problems. ! " ! "/ Cost of improvement for % -type supplier Optimal QE Contract Individual Rationality (Participation) constraints Incentive Compatibility (IC) constraints Moral hazard constraint Ø At the last stage of our analysis, we compare the optimal QE contracts that are implementable and identify the one that maximizes the manufacturer’s expected profit. 8
5/21/18 Agency Costs under QE Contract Moral Hazard followed by Adverse Selection Ø There are two types of agency costs under each equilibria: 1. Channel loss: When the decisions are different from first-best efforts. a) Direct cost: the manufacturer performs quality inspection, under which she incurs 𝜔 S with probability 𝛽 : . b) Indirect cost: where the supplier does not make quality improvement efforts where he does under first-best outcome. Channel loss under QE contract Agency Costs under QE Contract (Cont.) Moral Hazard followed by Adverse Selection Ø There are two types of agency costs: 2. Information rent: To satisfy the IC constraint of the ℎ -type supplier, the manufacturer has to pay a net amount, which the supplier will earn if he deviates and mimics the 𝑚 -type. a. Moral hazard term: when ℎ and 𝑚 types make different quality improvement efforts, i.e., 𝛾 0 ≠ 𝛾 1 . b. Reliability asymmetry term: because 𝑚 - and ℎ -type suppliers are inherently different in their degrees of reliability. Information rent under QE contract 9
Optimal QE Contract (Cont.) Optimal QE Contract 5/21/18 10
Recommend
More recommend
