Supplier Competition and Cost Improvement

Management Science, Forthcoming

33 Pages Posted: 4 Jan 2016

See all articles by Cuihong Li

Cuihong Li

University of Connecticut - Department of Operations & Information Management

Zhixi Wan

The University of Hong Kong - Faculty of Business and Economics

Date Written: December 12, 2015

Abstract

Buyers have two levers to enhance their supply base performance: fostering supplier competition and inducing suppliers to improve. The competition-improvement relation between the two levers has important implications for supply base design. We study a buyer facing two potential suppliers that can exert cost-reduction efforts, examining the interplay of supplier competition and supplier cost improvement under various information structures (i.e., the supplier effort is observable or unobservable) and commitment capabilities (i.e., the buyer may not commit, or may commit to a full or partial procurement mechanism, before suppliers exert efforts). We find that the two identical suppliers may choose unequal efforts, resulting in an asymmetric equilibrium outcome that enhances the performance of dual sourcing. Moreover, the competition-improvement relation depends on the effort observability. Whereas supplier competition always leads to lower improvement effort when the effort is unobservable, it may induce higher effort when the effort is observable. Thus, a tradeoff between supplier competition and supplier effort is not always necessary in supply base design. Comparing the observable- and unobservable-effort cases, we demonstrate a detrimental effect of supplier effort observability on the buyer profits. Finally, we show that more commitment expands the presence of asymmetric equilibria, enhancing dual sourcing, and the partial commitment strengthens the positive effect of competition on observable efforts while maintaining the detrimental effect of effort observability.

Keywords: Sourcing, Mechanism design, Hold-up, Supplier competition, Supplier improvement

Suggested Citation

Li, Cuihong and Wan, Zhixi, Supplier Competition and Cost Improvement (December 12, 2015). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2710343 or http://dx.doi.org/10.2139/ssrn.2710343

Cuihong Li (Contact Author)

University of Connecticut - Department of Operations & Information Management ( email )

368 Fairfield Road
Storrs, CT 06269-2041
United States

Zhixi Wan

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

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