Delegation vs. direct sourcing revisited: contract types under correlated supply risks and asymmetric cost information

Abstract

As a popular practice in purchasing, an ever-increasing number of upper-tier suppliers are being added in the supply base of the original equipment manufacturer (OEM) and leveraged to reduce supply risk. This new trend increases the OEM's opportunities to directly source from tier-2 suppliers (direct sourcing for better control) in addition to delegating tier-1 suppliers to source on behalf of the OEM itself (delegation). This paper is devoted to comparing these two mechanisms (delegation vs. direct souring) under both asymmetric information on the production costs of tier-2 suppliers and correlated supply disruptions with tier-2 suppliers. When the OEM offers a revenue-sharing term contract or a base-commitment term contract (in which the OEM is required to procure a fixed base quantity in addition to an option of procuring additional units at a pre-specified price) to a tier-1 supplier under delegation, delegation achieves the same profit for the OEM as direct sourcing does. However, under a fixed-quantity term contract, delegation achieves a lower profit for the OEM than direct sourcing does, no matter the CM is subject to the procurement budget constraint or deep pocket. Moreover, we find delegation may lead to a higher profit for the OEM than direct sourcing does if an improved fixed-quantity term contract is used under delegation with a deep-pocket CM.

Keywords:

• Multi-tier supply chain
• diversification
• disruption
• direct sourcing
• delegation
• deep-pocket supplier

Acknowledgments

The authors greatly appreciate the constructive comments of the reviewers, which were very helpful in improving the paper. Also, we would like to thank Heath Holtz, Information Director of Logistics at Nissan America, and the participants in the workshop on purchasing in China sponsored by Institute of Supply Management.

Disclosure statement

No potential conflict of interest was reported by the authors.

Supplemental data

Supplemental data for this article can be accessed at http://dx.doi.org/10.1080/00207543.2019.1689307.

Notes

1 See the link https://www.fas.org/sgp/crs/misc/R41831.pdf. Accessed on May 18, 2015.

2 http://www.sohu.com/a/323250896_100292428?scm=1002.44003c.fe01510165.PC_ARTICLE_REC&spm=smpc.content.fd-d.13.1563589714216mwpMFTm&_f=index_pagerecom_13

3 Note that our notation of reliability follows from Chaturvedi and Martínez-de-Albéniz (2011), but differs from Babich, Burnetas, and Ritchken (2007): on page 127 of Babich, Burnetas, and Ritchken (2007), $p_{00}$ is the probability with which both suppliers are reliable, $p_{11}$ is the probability with which both suppliers are not reliable, and $p_{10}$ (or $p_{01}$) is the probability with which only supplier 2 (or 1) is reliable.

4 Notably, because the revelation principle holds for any general cost distribution, our findings under the condition of independence between supplier costs can be extended to a correlated case, but the analysis becomes more complicated without adding further insights.

5 Myerson (1981) offers a method of constructing a convex hull when Assumption 1 does not hold. Similar method can be applied here.

6 When $c_2={\overline{c}}_2\left(c_1\right)$, CM is indifferent between choosing any supplier. For simplicity, in this case we assume that CM will randomly choose one.

7 Since ${\alpha }_2>{\alpha }_1$, when the more reliable supplier has a higher production cost, i.e. $c_2\ge {\overline{c}}_2\left(c_1\right)$, the OEM will set $w\le \left({\overline{c}}_2\left(c_1\right)-c_1\right)/\left({\alpha }_2-{\alpha }_1\right)$. Thus, in this case it is less likely to have a sufficiently large w in equilibrium.

Additional information

Funding

The first author, Jiguang Chen, is supported by the National Natural Science Foundation of China (NSFC: 71701112, 71801107, 71821001) and the Fundamental Research Funds for the Central Universities. The second and third authors, He Xu and Pin Zhou, are supported by the National Natural Science Foundation of China (NSFC: 71871099 and 71931005).