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

37 Pages Posted: 29 Sep 2008 Last revised: 3 Apr 2012

Zhibin (Ben) Yang

University of Oregon - Lundquist College of Business

Goker Aydin

University of Michigan at Ann Arbor - Department of Industrial and Operations Engineering

Volodymyr Babich

Georgetown University

Damian R. Beil

Stephen M. Ross School of Business

Date Written: September 5, 2011

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), 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.

Keywords: Supply Risk, Mechanism Design, Diversification

JEL Classification: L15, C72, D24, D82

Suggested Citation

Yang, Zhibin (Ben) and Aydin, Goker and Babich, Volodymyr and Beil, Damian R., Using a Dual-Sourcing Option in the Presence of Asymmetric Information about Supplier Reliability: Competition vs. Diversification (September 5, 2011). Ross School of Business Working Paper No. 1116. Available at SSRN: https://ssrn.com/abstract=1275110 or http://dx.doi.org/10.2139/ssrn.1275110

Zhibin (Ben) Yang (Contact Author)

University of Oregon - Lundquist College of Business ( email )

1208 University of Oregon
Eugene, OR 97403-1208
United States

Goker Aydin

University of Michigan at Ann Arbor - Department of Industrial and Operations Engineering ( email )

1205 Beal Avenue
Ann Arbor, MI 48109
United States

Volodymyr Babich

Georgetown University ( email )

37th and O St NW
McDonough School of Business
Washington, DC 20057
United States

HOME PAGE: http://explore.georgetown.edu/people/vob2/

Damian R. Beil

Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

HOME PAGE: http://https://sites.google.com/a/umich.edu/damianbeil/

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