Procurement in Supply Chains When the End-Product Exhibits the 'Weakest Link' Property

46 Pages Posted: 5 Jun 2012

See all articles by Stanley Baiman

Stanley Baiman

University of Pennsylvania - Accounting Department

Serguei Netessine

University of Pennsylvania - The Wharton School

Howard Kunreuther

National Bureau of Economic Research (NBER); University of Pennsylvania - Wharton Risk Management and Decision Processes Center

Date Written: February 1, 2004

Abstract

We consider a supply chain with one manufacturer who assembles an end-product using multiple outsourced parts. The end-product exhibits the “weakest-link” property, such that if any of its component parts fails, the end-product fails. The supplier of each component part can improve the (uncertain) quality of her parts by exerting costly effort that is unobservable to the manufacturer and is non-contractible. We analyze three possible contractual agreements between the manufacturer and suppliers: Acceptable Quality Level (AQL), Quality–Based Incentive Pricing (Q–Pricing) and Group Warranty. Under AQL, the manufacturer inspects all incoming parts, but establishes different quality thresholds and pays the suppliers different amounts for achieving the different thresholds. Under Q-Pricing, the manufacturer also inspects all incoming parts but pays each supplier a constant amount for each good part. Under Group Warranty there is no testing of the individual parts; instead all suppliers are responsible for any failed end-product. We compare the efficiency of these three contractual arrangements as a function of the exogenous variables.

Suggested Citation

Baiman, Stanley and Netessine, Serguei and Kunreuther, Howard C. and Kunreuther, Howard C., Procurement in Supply Chains When the End-Product Exhibits the 'Weakest Link' Property (February 1, 2004). Available at SSRN: https://ssrn.com/abstract=2077640 or http://dx.doi.org/10.2139/ssrn.2077640

Stanley Baiman

University of Pennsylvania - Accounting Department ( email )

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Serguei Netessine (Contact Author)

University of Pennsylvania - The Wharton School ( email )

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HOME PAGE: http://www.netessine.com

Howard C. Kunreuther

National Bureau of Economic Research (NBER)

University of Pennsylvania - Wharton Risk Management and Decision Processes Center ( email )

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