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

Abstract

This paper studies a dynamic procurement and production process used by many 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 cars 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.) We derive an optimal production policy and determine the equilibrium procurement contract, which depends on the price elasticity of consumer demand, input cost volatility, and the supplier's R&D and tooling costs. Our most important result is the equilibrium procurement contract under information asymmetry. We conclude by assessing the empirical support for our predictions using a unique data set of contractual arrangements provided to us by BMW. To the best of our knowledge, this is the first paper to provide empirical evidence for such theories in practice.

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