Using a Dual-Sourcing Option in the Presence of Asymmetric Information about Supplier Reliability: Competition vs. Diversification
Zhibin (Ben) Yang
University of Oregon - Charles H. Lundquist School of Business
University of Michigan at Ann Arbor - Department of Industrial and Operations Engineering
Georgetown University - McDonough School of Business
Damian R. Beil
University of Michigan, Stephen M. Ross School of Business
September 5, 2011
Ross School of Business Working Paper No. 1116
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), while 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.
Number of Pages in PDF File: 37
Keywords: Supply Risk, Mechanism Design, Diversification
JEL Classification: L15, C72, D24, D82
Date posted: September 29, 2008 ; Last revised: April 3, 2012
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