Supplier Centrality and Auditing Priority in Socially-Responsible Supply Chains

Abstract

Problem Definition and Academic/Practical Relevance: Most supply networks are characterized by firms that source from multiple suppliers and suppliers that serve multiple firms, thus resulting in suppliers who differ in their degree centrality, i.e., the number of firms they supply to. In such networks, any negative publicity from suppliers' noncompliance of socially-responsible practices – e.g., employment of child labor, unsafe working conditions, and excessive pollution – can significantly damage the reputation of the buying firms. To mitigate this impact, firms preemptively audit suppliers, although resource and time considerations typically restrict the number of suppliers a firm can audit. Therefore, a key question is whether firms should prioritize the auditing of suppliers with low or high centrality, ceteris paribus. To investigate, we consider an assembly network consisting of two firms (buyers) and three suppliers – each firm has one independent supplier who uniquely supplies to that firm and one common supplier who supplies to both.

Methodology: Game-Theoretic analysis.

Results and Managerial Implications: Downstream competition between the firms drives them away from auditing the supplier with higher centrality; i.e., the common supplier, in equilibrium, despite the fact that auditing this supplier is better for the aggregate profit of the firms. We show that this inefficiency is corrected when the firms cooperate (via a stable coalition) to jointly audit the suppliers and share the auditing cost in a fair manner. We also identify conditions under which joint auditing improves social welfare.

Keywords: supply network, social responsibility, joint-auditing, non-cooperative game, cooperative game

JEL Classification: C71, C72, M14