Supplier Diversification Under Buyer Risk

53 Pages Posted: 13 Feb 2019

See all articles by Jiri Chod

Jiri Chod

Boston College

Nikolaos Trichakis

Massachusetts Institute of Technology (MIT)

Gerry Tsoukalas

University of Pennsylvania - The Wharton School

Date Written: March 11, 2018

Abstract

When should a firm diversify its supply base? Most extant theories attribute supplier diversification to supplier risk. Herein, we develop a new theory that attributes supplier diversification to buyer risk. When suppliers are subject to the risk of buyer default, buyers may take costly action to signal creditworthiness so as to obtain more favorable terms. But once signaling costs are sunk, buyers sourcing from a single supplier become vulnerable to future holdup. Although ex ante supply base diversification can be effective at alleviating the holdup problem, we show that it comes at the expense of higher upfront signaling costs. We resolve the ensuing trade-off and show that diversification emerges as the preferred strategy in equilibrium. Our theory can help explain sourcing strategies when risk in a trade relationship originates from the sourcing firm, e.g., SMEs or startups; a setting which has eluded existing theories so far.

Keywords: Supplier Diversification, Multi-Sourcing, Buyer Default Risk, Signaling

Suggested Citation

Chod, Jiri and Trichakis, Nikolaos and Tsoukalas, Gerry, Supplier Diversification Under Buyer Risk (March 11, 2018). Management Science, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3328249 or http://dx.doi.org/10.2139/ssrn.3328249

Jiri Chod

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Nikolaos Trichakis

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Gerry Tsoukalas (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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