Procurement in Supply Chains when the End-Product Exhibits the “Weakest Link” Property

Abstract

We consider a supply chain with one manufacturer who assemble s 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. Th e 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 manufacture r inspects all incoming parts, bu t establishes different quality thresholds and pays the suppliers different amount s 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