How Does the Risk Attitude of a Purchasing Manager Affect the Selection of Suppliers?

Abstract

Recently researchers have integrated aspects of supply risk management into decision models for determining the optimal design of supply networks. A purchasing manager faces a fundamental trade-off when designing the supply network and deciding upon the allocation of purchasing volumes across a set of selected suppliers: additional suppliers may act as insurance against disruptions to supply and therefore safeguard supply. However, additional suppliers may also increase the purchasing and overhead costs. One important dimension of this trade-off has not been taken into consideration when evaluating different supplier network options: supplier selection constitutes a decision problem under risk, and so it is reasonable to assume that a purchasing manager’s risk attitude will significantly affect the final outcome. The research presented in this paper intends to provide insights into the potential impact of purchasing managers’ risk attitudes on their supplier selection decisions. We present the results of an artefactual field experiment with 54 managers from 12 industrial companies, and analyze which latent decisionmaking process and which risk attitude best characterizes the behavior of purchasing managers. We find that Expected Utility Theory and Prospect Theory provide complementary information on the risk attitudes of purchasing managers. Moreover, we illustrate the implications that risk attitudes other than risk neutrality may have on purchasing managers’ supplier selection decisions. We show that even for very conservative estimates of risk aversion it is not appropriate to assume a risk-neutral decision maker when applying a formal model to support supplier selection. We also highlight that the choice of a specific theory of decision making under risk is decisive for determining the optimal number of suppliers and their corresponding volume allocation when developing and applying supplier selection models under risk. In particular, we show why the choice of a purchasing budget for purchasing manager is so important: if it is too high it induces risk-loving behavior, and if it is too low it induces risk-averse behavior. Neither may accurately reflect the preferences of the overall company with respect to supply management decisions.

Keywords: purchasing, decision/risk/utility, experiments, simulation