Strategic risk in contract design

Supply chains facing asymmetric information can either operate in a cooperative mode with information and benefit sharing or can choose a non-cooperative form of interaction and align their incentives via screening contracts. In the cooperative mode, supply chain efficiency can be achieved, but high levels of trust and trustworthiness are required. In the non-cooperative mode, the contract mechanism guarantees a second best supply chain performance, but only if all parties choose their equilibrium strategies without trembles. Experimental evidence, however, shows that both operating modes often fail due to strategic risk. Cooperation is disrupted by deceptive signals and the lack of trust, whereas non-cooperative strategies suffer from persistent out-of-equilibrium behavior. We present an experiment on supply chain interaction with reduced strategic risk in both operating modes. We find that supply chain performance can reach a second-best level in either operating mode, if strategic risk is sufficiently reduced. We present two means to reduce strategic risk. First, a punishment mechanism leads to a better matching of trust and trustworthiness and supports the cooperative operating mode. Second, an enforcement of self-selection supports the non-cooperative equilibrium by increasing the attractiveness of screening contracts. We conclude that supply chain managers should seek to reduce the variability of the supply chain partners\u27 behavior no matter what operating mode is considered

Supply Chain Contracting in the Presence of Supply Uncertainty and Store Brand Competition

In today\u27s complex business environment, manufacturers are striving to maintain a competitive advantage over their supply chain partners. Manufacturers\u27 profitability is tightly linked to their strategic interactions with other entities in the supply chain. While numerous studies have been conducted to investigate such interactions in supply chains, certain issues remain unresolved. We apply a game-theoretic framework to analyze two distinct supply chain structures in the presence of supply uncertainty and store brand competition in two essays, respectively. In the first chapter, we study a decentralized assembly supply chain under supply uncertainty. In a decentralized assembly supply chain, one assembler assembles a set of $n$ components, each produced by a different supplier, into a final product to meet an uncertain market demand. Each supplier faces an uncertain production capacity such that only the lesser of the planned production quantity and the realized capacity can be delivered to the assembler. We assume that the suppliers\u27 random capacities and the random demand can follow an arbitrary continuous multivariate distribution. We formulate the problem as a two-stage Stackelberg game. The assembler and the suppliers adopt a so-called Vendor-Managed-Consigned-Inventory (VMCI) contract. We analytically characterize the equilibrium of this game, based on which we obtain several managerial insights. Surprisingly, we show that when a supplier\u27s production cost increases or when his component salvage value decreases, it hurts all other members and the entire supply chain, but it might sometimes benefit this particular supplier. Similarly, when the suppliers do not have supply uncertainty, it benefits the assembler but it does not necessarily benefit the suppliers. Furthermore, we demonstrate that when the suppliers\u27 capacities become more positively correlated, the assembler is always better off, but the suppliers might be better or worse off. Later in the chapter, we also solve the game under the conventional wholesale-price contract. We find that the assembler always prefers the VMCI contract, and the suppliers always prefer the wholesale price contract. In addition, we illustrate that the VMCI contract is more efficient than the wholesale price contract for this decentralized assembly supply chain. In the second chapter, we consider a two-tier decentralized supply chain with a national brand supplier and a retailer. The national brand supplier (she) distributes her products to consumers through the retailer. Meanwhile, the retailer (he) intends to develop and produce his own store brand through a manufacturing source that is different from the national brand supplier. The retailer holds the store brand production unit cost as private information, for which the national brand supplier only has a subjective assessment. Given a supply contract offered by the national brand supplier, the retailer simultaneously decides whether to accept the contract and whether to produce the store brand. The national brand supplier aims to design an optimal menu of contracts to maximize her expected profit as well as extract the retailer\u27s private cost information. We formulate the problem as a two-stage screening game to analyze the strategic interaction between the two players. Despite the inherent computational complexity, we are able to derive the optimal menu of contracts for the national brand supplier, of which the format depends on the national brand supplier\u27s unit production cost. Furthermore, we investigate how the model parameters affect the value of information for each member in the supply chain. We show that the retailer\u27s private cost information becomes less valuable to both the national brand supplier and the retailer when the national brand unit production cost increases. We also illustrate that when the gap between the two possible cost values increases, the private cost information becomes more valuable to the national brand supplier, however the value of information to the retailer himself can either increase or decrease. Finally, we demonstrate that when the perceived quality of the national brand increases, the value of information to the retailer first decreases then increases, but the impact on the value of information to the national brand supplier can be either positive or negative

Trust and Trustworthiness in Imbalanced Markets

In this thesis, we use the methodology of experimental economics to investigate issues of trust and trustworthiness in procurement and the supply chain. First, we develop a procurement model in which both seller-side and buyer-side decisions are endogenous to the trading relationship. We investigate how a real-world contractual incentive mechanism, retainage, can be used to overcome the seller-side moral hazard problem. We find that retainage can improve trade efficiency but in-creases market prices and may deter participation. We offer managerial insights on how to design the retainage mechanism, conditional on levels of trust and trustworthiness. Second, we extend the procurement model to incorporate a contingent contract and show analytically that this contract can mitigate the seller-side moral hazard problem. We observe in a lab experiment that suppliers strategically adjust their bids with a contingent contract and that the contingent contract has unintended behavioural con-sequences, with buyers rewarding sellers less for the quality of works delivered. The results have managerial implications for the use of hierarchical elements in contracts. Third, we analyse theoretically and experimentally the horizontal effects of supply chain late payments. We show that if firms discount payment received after the standard term, then late payments feed into higher prices and reduced competition. Reneging on a standard payment term entails a penalty for the buyer set by a third-party. If this penalty is not set carefully, a welfare loss arises due to price externalities. We demonstrate how free-riding payment behaviours may emerge among financially weaker buyers in the firm population