Resource title

Collaborative cost reduction and component procurement under information asymmetry

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Resource description

Firms manufacturing highly innovative and complex products often rely on the expertise of their suppliers who provide critical components that enable core functionality of the products. During the product development stage there is often considerable uncertainty about component production cost, and it is of interest to both the manufacturer and the supplier to engage in a collaborative effort to reduce the expected unit cost as well as uncertainty around it. Despite the obvious benefits of cost reduction, however, the supplier may be reluctant to collaborate, as he wishes to guard against revealing his proprietary cost information. Building on the traditional frameworks of the newsvendor model and adverse selection, we investigate how information asymmetry and the structure of procurement contracts interact to influence the supply chain parties’ incentives to collaborate. We consider a number of contracts based on price and quantity, and identify a simple contract, Expected Margin Commitment (EMC), that effectively promotes collaboration. The manufacturer prefers EMC if (a) collaboration leads to a large reduction in unit cost and/or (b) demand variability is low. Otherwise, a screening contract is preferred. We also find that, paradoxically, ex-post efforts to enhance supply chain efficiency may hinder ex-ante collaboration that precedes production.

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Resource language

en

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application/pdf

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http://flora.insead.edu/fichiersti_wp/inseadwp2010/2010-106.pdf

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Copyright INSEAD. All rights reserved