Managing Engineering Design for Competitive Sourcing in Closed‐Loop Supply Chains

We examine the strategic interplay between a buyer's design decision and the ensuing competition between suppliers in a three‐tier closed‐loop supply chain setting with significant recycling considerations. The nature of the engineering design decision in our research entails choice of integral versus modular design that has direct implications for the input raw material waste and ensuing competition between suppliers (i.e., incumbent and new). Whereas the integral design requires a large blank and generates excessive material scrap, the modular design reduces the generated scrap, and enhances cut‐to‐fit modularity, but incurs joining cost and yield loss. The incumbent supplier who supports the status quo choice of integral design can effectively recycle excessive material waste, as it is strategically located close to the source of material. The engineering design team at our study firm is currently exploring the option to source from alternative suppliers that can support either integral or modular designs, but have significantly lower effectiveness in recycling scrap material. We characterize the buyer's price sensitivity levels, component characteristics, supply chain configurations, and virgin and scrap specialty material prices that yield various design and sourcing policy alternatives. The buyer's optimal policy choice, the ensuing price–demand dynamics, and the resulting recycling implications demonstrate that the buyer can benefit from strategically tailoring his design decisions to affect the suppliers' material requirements and costs. We show that utilizing an alternative supply option is particularly valuable for components made from a material with a low price differential in virgin and scrap forms in supply chains wherein the new supplier base can recycle effectively. In such cases, the buyer induces severe price competition by dual sourcing the integral design, and competition may negate the seemingly obvious benefits of operational improvements (e.g., higher scrap material return rate).      

A Generalized Framework for Quantity Discount Pricing Schedules

The use of price to influence a buyer's purchasing behavior and thus improve supply chain coordination has received considerable attention. The vendor and buyer are independent economic entities, each maximizing its own profit. We consider the case of a buyer with fixed annual demand, independent of cost. The vendor's objective is to set a price schedule that encourages the buyer to raise its order quantity, increasing the vendor's profits. We present a unified treatment of the problem, categorize different variations, and provide a common solution procedure for all cases.     

Requirement or Promise? An Analysis of the First‐Mover Advantage in Quality Contracting

Quality contracting is critical and challenging due to the many unique issues related to quality. In this study, we analyze the first‐mover right in quality contracting by considering two different strategies for the buyer: the quality requirement strategy (QR) where buyer moves first by posting quality requirement to suppliers and quality promise strategy (QP) where buyer voluntarily gives up the first‐mover right to suppliers to ask them to promise quality. We study which strategy (1) better encourages suppliers' quality improvement efforts and (2) leads to a higher expected profit for the buyer. To analyze the drivers behind the buyer's choice between QR and QP, we start with the basic model where buyer faces only one supplier who has the opportunity to make quality improvements. We then gradually add other business features such as information asymmetry and supplier competition, analyzing how each feature adds/changes the driving forces and how they interact in the buyer's decision between QR and QP. We consider both the case where the wholesale price is fixed (when the buyer has the power to dictate price or price is set by the market) and the case where the wholesale price is included as a variable (when price is part of the negotiation). We find that QP always leads to the first‐best quality efforts from the supplier(s) while QR limits their efforts. However, this does not guarantee higher expected profit for the buyer under QP. We provide insightful guidelines in buyer's choice between QP and QR. This research enriches the limited literature on quality contracting with quality improvement opportunity and asymmetric information.     

Push or Pull? Auctioning Supply Contracts

Consider a buyer, facing uncertain demand, who sources from multiple suppliers via online procurement auctions (open descending price‐only auctions). The suppliers have heterogeneous production costs, which are private information, and the winning supplier has to invest in production capacity before the demand uncertainty is resolved. The buyer chooses to offer a push or pull contract, for which the single price and winning supplier are determined via the auction. We show that, with a pull contract, the buyer does not necessarily benefit from a larger number of suppliers participating in the auction, due to the negative effect of supplier competition on the incentive of supplier capacity investment. We thus propose an enhanced pull mechanism that mitigates this effect with a floor price. We then analyze and compare the outcomes of auctions for push and (enhanced) pull contracts, establishing when one form is preferred over the other based on the buyer's profits. We also compare our simple, price‐only push and pull contract auctions to the optimal mechanisms, benchmarking the performance of the simple mechanisms as well as establishing the relative importance of auction design and contract design in procurement auctions.     

Multiperiod Models with Capacities in Competitive Supply Chain

This paper considers a supply chain setting where several capacitated suppliers compete for orders from a single retailer in a multiperiod environment. At each period, the retailer places orders to the suppliers in response to the prices they announce. Each supplier has a fixed capacity. We consider a make‐to‐stock setting where the retailer can carry inventory. The retailer faces exogenous, price‐dependent demand. We study the problem using ideas from fluid models. In particular, we (i) analyze when there are pure equilibrium policies in this setting and characterize the structure of these policies; (ii) consider coordination mechanisms; and (iii) present some preliminary computational results. We also consider a modified model that uses option contracts to coordinate the supply chain.     

Flexibility or Cost Saving? Sourcing Decisions with Two Suppliers

This article studies a decentralized supply chain in which there are two suppliers and a single buyer. One supplier offers the quantity flexibility (QF) contract to the buyer, while the other offers the cheaper price. Under the QF contract, the buyer does not assume full responsibility for the forecast, yet the supplier guarantees the availability of the forecasted quantity with additional buffer inventory. On the other hand, the price‐only contract places full inventory burden on the buyer, but with a cheaper price. We study this problem from the buyer's perspective and solve for the buyer's optimal procurement and forecasting decisions. We identify areas where flexibility and cheaper price have an advantage, one over the other. Our results indicate that the buyer significantly benefits from having multiple sources of supply. We also find that, from the system's standpoint, a multisupplier system may outperform a single‐supplier supply chain under certain conditions. Interestingly, we observe that providing too much flexibility may benefit the low‐price supplier rather than benefiting the QF supplier. We discuss the managerial implications and provide directions for future research opportunities.     

Sourcing Decisions with Competitive Suppliers and Imperfect Information

Manufacturers often must choose between outsourcing and producing internally. This choice is complex and influenced by a variety of factors, including the costs and capabilities of the potential suppliers. In addition, if the manufacturer outsources, he must design the sourcing process. We study the manufacturer's outsourcing decision, with a focus on the impact of the sourcing process on that decision. We consider a setting in which the manufacturer has imperfect information regarding the suppliers' costs and capabilities, and we assume that the manufacturer uses a two‐stage sourcing process. The first stage is the qualification stage, in which the manufacturer seeks to reduce the uncertainty regarding the suppliers' capabilities. The second stage is the supplier selection stage, in which the manufacturer selects among the qualified suppliers on the basis of price. We first characterize the optimal design of the two‐stage process, and then consider the outsourcing decision. We demonstrate several trade‐offs. Vertical integration enables the manufacturer to reduce uncertainty and extract all of the profits of production. However, outsourcing enables the manufacturer to take advantage of the (potentially) lower costs and higher capabilities of the suppliers, particularly if competition between suppliers can be encouraged. We find that the manufacturer is more likely to vertically integrate when the warranty cost and the cost of exerting effort during qualification are large, and when there is significant uncertainty regarding the suppliers' capabilities. The manufacturer is more likely to outsource when the suppliers' costs (capabilities) are low (high), and when the number of suppliers is large.     

Mechanisms to Induce Buyer Forecasting: Do Suppliers Always Benefit from Better Forecasting?

In this study, we consider a supplier's contract offerings to a buyer who may obtain improved forecasts for her demand over time. We investigate how the supplier can take advantage of the buyer's better forecasts and what kind of contracts he should offer to the buyer in order to maximize his profits. We model a natural forecast evolution where the buyer can obtain a more accurate forecast closer to the selling season. We assume there is information asymmetry between the buyer and the supplier at all times in that the buyer understands her demand better than the supplier. Three types of contracts that the supplier can offer are considered: (1) one where a contract is offered before the buyer has a chance to obtain improved forecasts, (2) one where a contract is offered after the buyer has obtained improved forecasts, and (3) a contingent (dynamic) contract which offers an initial contract to the buyer before she obtains improved forecasts, followed by a later contract (contingent on the initial contract) offered after improved forecasts have been obtained. We consider two scenarios: (1) where the supplier is certain that the buyer can obtain more accurate forecasts over time, and (2) where the supplier is uncertain about the buyer's forecasting capability (or forecasting cost). In the first scenario, we show that among the three types of contracts, the contingent contract is always the most profitable for the supplier. Furthermore, using the contingent contract, the supplier always benefits from higher accuracy of the buyer's demand forecasts. In the second scenario, we explicitly model the supplier's level of certainty about the buyer's capability of obtaining better forecasts, and explore how the supplier can design contracts to induce the buyer to obtain better forecasts when she is capable.     

Supplier competition and its impact on firm׳s sourcing strategy

Most research on firms׳ sourcing strategies assumes that wholesale prices and reliability of suppliers are exogenous. It is of our interest to study suppliers׳ competition on both wholesale price and reliability and firms׳ corresponding optimal sourcing strategy under complete information. In particular, we study a problem in which a firm procures a single product from two suppliers, taking into account suppliers׳ price and reliability differences. This motivates the suppliers to compete on these two factors. We investigate the equilibria of this supplier game and the firm׳s corresponding sourcing decisions. Our study shows that suppliers׳ reliability often plays a more important role than wholesale price in supplier competition and that maintaining high reliability and a high wholesale price is the ideal strategy for suppliers if multiple options exist. The conventional wisdom implies that low supply reliability and high demand uncertainty motivate dual-sourcing. We notice that when the suppliers׳ shared market/transportation network is often disrupted and demand uncertainty is high, suppliers׳ competition on both price and reliability may render the sole-sourcing strategy to be optimal in some cases that depend on the format of suppliers׳ cost functions. Moreover, numerical study shows that when the cost or vulnerability (to market disruptions) of one supplier increases, its profit and that of the firm may not necessarily decrease under supplier competition.     

The Effect of Learning and Integration Investment on Manufacturing Outsourcing Decisions: A Game Theoretic Approach

We introduce a two‐period Stackelberg game of a supplier and buyer. We recognize that learning from manufacturing experience has many advantages. Consistent with the literature, we assume both the buyer and supplier realize reductions in their respective production costs in period 2 due to volume‐based learning from period 1 production. In addition, we introduce another learning concept, the future value, to capture the buyer's benefits of transferring current manufacturing experience for the design and development of future products and technologies. In contrast to the literature, we allow the supplier two mechanisms to impact the buyer's outsourcing decision: price and the investment in integration process improvement (IPI) that reduces the buyer's unit cost of integration. IPI may include the investment in new materials, specialized technology, or the re‐design of the integration process. Conditions are given whereby the buyer partially outsources component demand as opposed to fully outsourcing or fully producing in‐house. Furthermore, conditions are given characterizing when the supplier's price and investment in IPI are substitute strategies versus complements. Both analytic and numerical results are presented.     

Profit Seeking vs. Survival Seeking: An Analytical Study of Supplier's Behavior and Buyer's Subsidy Strategy

Supplier default is common in emerging markets. Suppliers under the threat of default have different objectives from profit‐seeking companies. This paper analytically tests how profit‐seeking or survival‐seeking behavior, single‐period or two‐period consideration, and buyer's subsidy influence the supplier's and buyer's final utilities. The results show that under single‐period consideration, the supplier's survival‐seeking strategy in fact drives more start‐ups or small suppliers out of business when the competition becomes severe; under two‐period consideration, no matter which strategy (profit‐seeking or survival‐seeking) the supplier selects, the second‐period price and profit are always higher than those of the first period. Furthermore, we find that providing subsidy is an effective way for buyer to keep suppliers’ competition at a certain level on the behalf of buyer's interest. By numerically estimating the benefits associated with the cost of subsidy, we provide a basis for understanding the cost–benefit analysis of buyer's subsidy strategy.     

With or Without Forecast Sharing: Competition and Credibility under Information Asymmetry

Forecast sharing among trading partners lies at the heart of many collaborative and contractual supply chain management efforts. Even though it has been praised in both academic and practitioner circles for its critical role in increasing demand visibility, some concerns remain: The first one is related to the credibility of forecast sharing, and the second is the fear that it may turn into a competitive disadvantage and induce suppliers to increase their price offerings. In this study, we explore the validity of these concerns under a supply chain with a competitive upstream structure, focusing specifically on (i) when and how a credible forecast sharing can be sustainable, and (ii) how it impacts on the intensity of price competition. To address these issues, we develop a supply chain model with a buyer facing a demand risk and two heterogeneous suppliers competing for order allocation from the buyer. The extent of demand is known only to the buyer. The buyer submits a buying request to the suppliers via a commonly used procurement mechanism called request for quotation (RFQ). We consider two variants of RFQ. In the first type, the buyer simply shares the estimated order quantity with no further specifications. In the second one, in addition to this, the buyer also specifies minimum and/or maximum order quantities. We fully characterize equilibrium decisions and profits associated with them under symmetric and asymmetric information scenarios. Our main findings are that the buyer can use a RFQ with quantity restrictions as a credible signal for forecast sharing as long as the degree of demand information asymmetry is not too high, and that, contrary to above concerns, the equilibrium prices that emerge between competing suppliers under asymmetric information may indeed increase if the buyer cannot share forecast information credibly with its upstream partners.     

Capacity Allocation among Multiple Suppliers in an Electronic Market

An electronic marketplace typically provides industrial suppliers an alternative option for selling their capacity in addition to the traditional open market. However, suppliers face different sets of costs and risks in open market and in electronic market. Consequently, suppliers participating in an electronic market are likely to offer their capacity at a different price compared with traditional open market. We analyze this problem and derive the price‐capacity function for the supplier. We also derive a basis for allocating buyer's requirements among multiple suppliers so as to minimize his cost. Our model shows that suppliers with large capacities would quote a lower price in the electronic market. It also predicts that the unit bid price increases with bid quantity in the electronic market. Based on the price‐capacity curve, we model a scenario where the buyer announces, a priori, the number of suppliers to be selected for award of a contract that will minimize its costs.     

A WTP‐Choice Model: Empirical Validation,Competitive and Centralized Pricing

Willingness To Pay (WTP) of customers plays an anchoring role in pricing. This study proposes a new choice model based on WTP, incorporating sequential decision making, where the products with positive utility of purchase are considered in the order of customer preference. We compare WTP‐choice model with the commonly used (multinomial) Logit model with respect to the underlying choice process, information requirement, and independence of irrelevant alternatives. Using WTP‐choice model, we find and compare equilibrium and centrally optimal prices and profits without considering inventory availability. In addition, we compare equilibrium prices and profits in two contexts: without considering inventory availability and under lost sales. One of the interesting results with WTP‐choice model is the “loose coupling” of retailers in competition; prices are not coupled but profits are. That is, each retailer should charge the monopoly price as the collection of these prices constitute an equilibrium but each retailer's profit depends on other retailers' prices. Loose coupling fails with dependence of WTPs or dependence of preference on prices. Also, we show that competition among retailers facing dependent WTPs can cause price cycles under some conditions. We consider real‐life data on sales of yogurt, ketchup, candy melt, and tuna, and check if a version of WTP‐choice model (with uniform, triangle, or shifted exponential WTP distribution), standard or mixed Logit model fits better and predicts the sales better. These empirical tests establish that WTP‐choice model compares well and should be considered as a legitimate alternative to Logit models for studying pricing for products with low price and high frequency of purchase.     

Strategic Sourcing in the Presence of Uncertain Supply and Retail Competition

This study develops an analytical model to evaluate competing retail firms' sourcing strategies in the presence of supply uncertainty. We consider a common supplier that sells its uncertain supply to two downstream retail firms engaging in price competition in a horizontally differentiated product market. The focal firm has a dual‐sourcing option, while the rival firm can only source from the common supplier. We assess the system‐wide effects of supply uncertainty on the focal firm's incentive to pursue the dual‐sourcing strategy. We find that the focal firm's dual‐sourcing strategy can create a win–win situation that leads to increased retail prices and expected profits for both firms. Furthermore, under certain conditions, we show that it is beneficial for the focal firm to strategically source from the common supplier, even if its alternative supplier offers a lower wholesale price. Overall, we identify two types of incentives for adopting the dual‐sourcing strategy: the incentive of mitigating supply risk through supplier diversification and the incentive of strategic sourcing for more effective retail competition.     

Procurement with Reverse Auction and Flexible Noncompetitive Contracts

This article investigates a hybrid procurement mechanism that combines a reverse auction with flexible noncompetitive contracts. A buyer adopts such mechanism to procure multiple units of a product from a group of potential suppliers. Specifically, the buyer first offers contracts to some suppliers who, if accepting the contract, do not participate in the auction while committing to selling a unit to the buyer at the price of the subsequent auction. For the suppliers rejecting the offers, they can join the subsequent auction with the other suppliers to compete on the remaining units. When the buyer offers only one flexible noncompetitive contract, we find that the selected supplier may accept the offer regardless of whether he knows his exact cost information. Meanwhile, the buyer can benefit from offering such a contract, as opposed to solely conducting a regular reverse auction or offering a noncompetitive contract that does not allow suppliers declining offers to join the subsequent auction. Moreover, we find that the suppliers' information about their own costs has a significant impact on the buyer's decision. When the buyer makes multiple offers, we analyze the resulting game behavior of the selected suppliers and demonstrate that the buyer can benefit more than just offering one such contract. Therefore, the hybrid procurement mechanism can be mutually beneficial for both the buyer and the selected suppliers.     

An Auction Mechanism for Pricing and Capacity Allocation with Multiple Products

We consider a pricing and short‐term capacity allocation problem in the presence of buyers with orders for bundles of products. The supplier's objective is to maximize her net profit, computed as the difference between the revenue generated through sales of products and the production and inventory holding costs. The objective of each buyer is similarly profit maximization, where a buyer's profit is computed as the difference between the time‐dependent utility of the product bundle he plans to buy, expressed in monetary terms, and the price of the bundle. We assume that bundles' utilities are buyers' private information and address the problem of allocating the facility's output. We directly consider the products that constitute the supplier's output as market goods. We study the case where the supplier follows an anonymous and linear pricing strategy, with extensions that include quantity discounts and time‐dependent product and delivery prices. In this setting, the winner determination problem integrates the capacity allocation and scheduling decisions. We propose an iterative auction mechanism with non‐decreasing prices to solve this complex problem, and present a computational analysis to investigate the efficiency of the proposed method under supplier's different pricing strategies. Our analysis shows that the problem with private information can be effectively solved with the proposed auction mechanism. Furthermore, the results indicate that the auction mechanism achieves more than 80% of the system's profit, and the supplier receives a higher percentage of profit especially when the ratio of demand to available capacity is high.     

Role of Random Capacity Risk and the Retailer in Decentralized Supply Chains with Competing Suppliers

This research considers a supply chain under the following conditions: (i) two heterogeneous suppliers are in competition, (ii) supply capacity is random and pricing is endogenous, (iii) consumer demand, with and without an intermediate retailer, is price dependent. Specifically, we examine how uncertainty in supply capacity affects optimal ordering and pricing decisions, supplier and retailer profits, and the incentives to reduce such uncertainty. When two suppliers sell through a monopolistic retailer, supply uncertainty not only affects the retailer's diversification strategy for replenishment, but also changes the suppliers’ wholesale price competition and the incentive for reducing capacity uncertainty. In this dual‐sourcing model, we show that the benefit of reducing capacity uncertainty depends on the cost heterogeneity between the suppliers. In addition, we show that a supplier does not necessarily benefit from capacity variability reduction. We contrast this incentive misalignment with findings from the single‐supplier case and a supplier‐duopoly case where both suppliers sell directly to market without the monopolistic retailer. In the latter single‐supplier and duopoly cases, we prove that the unreliable supplier always benefits from reducing capacity variability. These results highlight the role of the retailer's diversification strategy in distorting a supplier's incentive for reducing capacity uncertainty under supplier price competition.     

Supplier–Buyer Negotiation Games: Equilibrium Conditions and Supply Chain Efficiency

In a decentralized supply chain, supplier–buyer negotiations have a dynamic aspect that requires both players to consider the impact of their decisions on future decisions made by their counterpart. The interaction generally couples strongly the price decision of the supplier and the quantity decision of the buyer. We propose a basic model for a repeated supplier–buyer interaction, during several rounds. In each round, the supplier first quotes a price, and the buyer places an order at that price. We find conditions for existence and uniqueness of a well‐behaved subgame‐perfect equilibrium in the dynamic game. When costs are stationary and there are no holding costs, we identify some demand distributions for which these conditions are met, examine the efficiency of the equilibrium, and show that, as the number of rounds increases, the profits of the supply chain increase towards the supply chain optimum. In contrast, when costs vary over time or holding costs are present, the benefit from multi‐period interactions is reduced and after a finite number of time periods, supply chain profits stay constant even when the number of rounds increases.     

Managing Disruptions in Decentralized Supply Chains with Endogenous Supply Process Reliability

Supply disruptions are all too common in supply chains. To mitigate delivery risk, buyers may either source from multiple suppliers or offer incentives to their preferred supplier to improve its process reliability. These incentives can be either direct (investment subsidy) or indirect (inflated order quantity). In this study, we present a series of models to highlight buyers’ and suppliers’ optimal parameter choices. Our base‐case model has deterministic buyer demand and two possibilities for the supplier yield outcomes: all‐or‐nothing supply or partial disruption. For the all‐or‐nothing model, we show that the buyer prefers to only use the subsidy option, which obviates the need to inflate order quantity. However, in the partial disruption model, both incentives—subsidy and order inflation—may be used at the same time. Although single sourcing provides greater indirect incentive to the selected supplier because that avoids order splitting, we show that the buyer may prefer the diversification strategy under certain circumstances. We also quantify the amount by which the wholesale price needs to be discounted (if at all) to ensure that dual sourcing strategy dominates sole sourcing. Finally, we extend the model to the case of stochastic demand. Structural properties of ordering/subsidy decisions are derived for the all‐or‐nothing model, and in contrast to the deterministic demand case, we establish that the buyer may increase use of subsidy and order quantity at the same time.