Bargaining Power and Supply Base Diversification

41 Pages Posted: 3 Dec 2008 Last revised: 7 Feb 2014

Zhixi Wan

University of Oregon - Department of Operations and Business Analytics

Damian R. Beil

Stephen M. Ross School of Business

Date Written: December 1, 2009

Abstract

We examine a supply base diversification problem faced by a buyer who periodically holds auctions to award short term supply contracts among a cohort of suppliers (i.e., the supply base). To mitigate significant cost shocks to procurement, the buyer can diversify her supply base by selecting suppliers from different regions. We find that the optimal degree of supply base diversification depends on the buyer’s bargaining power, i.e., the buyer’s ability to choose the auction mechanism. At one extreme, when the buyer has full bargaining power and thus can dictatorially implement the optimal mechanism, she prefers to fully diversify. At the other extreme, when the buyer uses a reverse English auction with no reserve price due to her lack of bargaining power, she may consider protecting herself against potential price escalation from cost-advantaged suppliers by using a less diversified supply base. We find that in general the more bargaining power the buyer has to control price escalation from cost-advantaged suppliers the more she prefers a diversified supply base. This insight is shown to be robust to correlation between regional costs, asymmetry across regions, and intermediate levels of bargaining power.

Keywords: Procurement, diversification, auctions

JEL Classification: D44, H57, C72, C78, D81

Suggested Citation

Wan, Zhixi and Beil, Damian R., Bargaining Power and Supply Base Diversification (December 1, 2009). Ross School of Business Paper No. 1118. Available at SSRN: https://ssrn.com/abstract=1287164

Zhixi Wan

University of Oregon - Department of Operations and Business Analytics ( email )

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

Damian R. Beil (Contact Author)

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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