A Game of Investment in Supplier Quality with Spillover Effects
H. Dharma Kwon
University of Illinois at Urbana-Champaign - Department of Business Administration
University of Illinois at Urbana-Champaign
Cornell University - Samuel Curtis Johnson Graduate School of Management
June 1, 2011
Johnson School Research Paper Series No. 29-2011
We investigate optimal strategies for firms to invest in quality improvement at their suppliers when the benefits of such investments can spill over to other firms who source from the same suppliers. We model two Bayesian firms who can invest in improving the quality of their common supplier; the firms do not have complete information on the true quality of the supplier, but they update their beliefs based on the supplier’s quality performance. We formulate the problem as a real options game and obtain Markov's perfect equilibria characterized by the investment thresholds of both firms. We also examine the impact of spillover on the investment threshold and the time to first investment. Quality spillover, which refers to the spillover of quality improvement from one firm to the other, tends to reduce the first investment threshold and the time to first investment. In contrast, information spillover, which refers to the spillover of information about the supplier’s true quality as a result of additional information on supplier performance, increases the first investment threshold and increases or decreases the time to first investment depending on the model parameters.
Number of Pages in PDF File: 32
Keywords: manufacturing, performance/productivity, reliability, quality control, decision analysis, inference, games/group decisions, stochastic, probability, diffusionworking papers series
Date posted: June 7, 2011
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