Information Asymmetry, Rents, and Cost Risk Allocation: An Investigation of the BMW Supply Chain

Abstract

This paper studies a dynamic procurement process used by many European automakers and BMW in particular. An automaker (she) must procure components from an upstream supplier (him) to assemble cars in a given production period. Demand for vehicles is stochastic, and retail prices are endogenous. The automaker may or may not be privy to the supplier's raw material product cost, which is also stochastic. In the former case, we say that information is symmetric; in the latter case, information is asymmetric. (Existing work in this area is limited to static models with deterministic demand and symmetric information.) The contracts BMW uses are the material-plus-surcharge (MPS) and the fixed price contract (FP). In that environment, we explain how to choose between the contracts that BMW uses currently, and we identify a new, optimal contract for the asymmetric case that would net the automaker an additional profit boost. We conclude by assessing the empirical support for our predictions using a unique data set of contractual arrangements provided to us by BMW. Our analysis sharpens our understanding of contract choice in dynamic procurement settings and identifies a list of key factors in making such choices.

Keywords: asymmetric information, risk management, commodity, automotive, empirical