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

The Wharton School, University of Pennsylvania

Howard Kunreuther

University of Pennsylvania - Operations, Information and Decisions Department; National Bureau of Economic Research (NBER)

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., 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 )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6782 (Phone)
215-573-2054 (Fax)

Serguei Netessine (Contact Author)

The Wharton School, University of Pennsylvania ( email )

3730 Walnut Street
Philadelphia, PA 19104-6367
United States
(215) 573 3571 (Phone)

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

Howard C. Kunreuther

University of Pennsylvania - Operations, Information and Decisions Department ( email )

3730 Walnut Street
558 & 559 Jon M. Huntsman Hall
Philadelphia, PA 19104-5340
United States
212-854-0423 (Phone)
215-573-2130 (Fax)

National Bureau of Economic Research (NBER)

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