We investigate procurement in a setting in which the buyer is bound by sourcing rules. Sourcing rules may limit the minimum and maximum amounts of business that can be awarded to a single supplier or ...dictate the minimum number of suppliers who are awarded business, thus necessitating split awards. The buyer announces the splits before the auction, and suppliers bid accordingly. We consider two auction formats: the sealed-bid first-price auction, and a version of the open-bid descending-price auction. We characterize the suppliers’ symmetric equilibrium bidding strategy for both formats and find that the two formats yield the same expected buyer’s cost. We characterize the cost of multisourcing, showing among other things that it is always costly for the buyer to split its award among more suppliers if the suppliers’ costs are regularly distributed, but that doing so can actually reduce the buyer’s expected auction payment if the suppliers’ costs are not regularly distributed. The results from controlled laboratory experiments, involving human subjects, indicate that expected cost equivalence fails when costs are regularly distributed because suppliers bid more aggressively in the sealed-bid auction. However, for split-award auctions with nonregularly distributed costs, the sealed-bid prices are actually higher than predicted by theory. We explain these mismatches between observations and theory through a behavioral model based on bidders’ aversion to anticipated regret. The experimental results indicate that the theory does a good job of predicting the relationship between the buyer’s average cost and the award splits, as well as the cost of multisourcing. Importantly, the experiments confirm that when suppliers’ costs come from a nonregular distribution, it may be to the buyer’s advantage to diversify the supply base more than is strictly necessitated by sourcing rules.
The online appendix is available at
https://doi.org/10.1287/mnsc.2017.2932
.
This paper was accepted by Vishal Gaur, operations management.
We consider a multi‐item buyer's make versus buy decision. The buyer sells two substitutable products with uncertain demand. Each product requires a different item, which the buyer procures from two ...separate suppliers (one for each item) who offer quantity‐payment contracts under asymmetric information. The buyer can make one of the items but not both. We compare the buyer's expected profit between buying both the items and making one item (and buying the other), when it can make the item at the same cost as the supplier, as well as gain reactive production capability by making. We find that the buyer's profit when buying both items is higher than for making one item if product substitutability is above a threshold (but not extremely high). This is because the interaction between the suppliers' contracts increases the buyer's informational rents more when buying from both suppliers, as compared to one supplier, as product substitutability increases. On the contrary, in the complete information scenario (and under wholesale price contracts), we find that the buyer will never prefer to buy both the items as compared to making one item, as long as product substitutability is not extremely high. These are novel findings on how inter‐linked contracts under incomplete information and product substitutability can influence a buyer's make versus buy decision in a counter‐intuitive manner. Managerially, these results imply that a multi‐product buyer may prefer to keep buying from its supplier even when it can produce the item at the same cost as the supplier.
Supplier non‐performance is an ever present problem for an original equipment manufacturer (OEM) buyer and past survey‐based research has shown that increasing supplier competition adversely affects ...their performance. Using a reverse auction setting in which supplier competition is determined by number (n) of participating suppliers (bidders), we show how buyer's exposure to supplier non‐performance risk is influenced by n. In particular, we characterize conditions under which supplier non‐performance risk is increasing in n. We then formulate a buyer's decision on the optimal n for uniformly distributed costs that allows it to resolve its cost vs. risk trade‐off. We further investigate other strategies like dual sourcing, better screening, and lower threshold on acceptable bids, that the buyer can use, together with limiting n, to limit non‐performance risk and control its overall procurement cost. Managerially, our findings indicate that an OEM buyer procuring non‐strategic (non‐critical) components could increase its exposure to supplier non‐performance risk by leveraging too much competition, especially among small entrant suppliers. In such situations a buyer can manage its input cost and risk by limiting supplier competition.
•Characterize asymmetric bidding equilibrium in pay-as-bid procurement auction.•Provide comparative statics on the bidding equilibrium.•Provide an open auction implementation when suppliers have ...capacity constraints.•Open auction format is optimal and gives lower expected cost than sealed auction.
In this paper we study two reverse auction formats in a single period setting, the sealed pay-as-bid and the open format, when suppliers are capacity constrained. In the pay-as-bid format we characterize the asymmetric bidding equilibrium for the case of two suppliers with uniformly distributed cost. We find that the pay-as-bid auction allocates business inefficiently and that a supplier’s bid is nonincreasing in the opponent’s capacity and is typically decreasing in its own capacity. We then characterize a descending price-clock open auction implementation and find that it is optimal and that the buyer’s expected cost decreases as capacity is more evenly spread. Finally, we find that the pay-as-bid auction results in a higher expected cost to the buyer as compared to the open auction.
In dynamic markets where cost of components changes fast, buyers typically auction off regular short-term contracts to fully leverage supplier competition in each period to continuously source from ...the lowest-cost supplier. However, too much competition through short-term contracts does not incentivize the incumbent supplier to make relation-specific investments in reducing costs, as future business is not assured. We investigate this trade-off, between leveraging supplier competition in each period versus incentivizing incumbent’s investment, with a stylized two-period model in which the buyer decides whether to auction off short-term contracts in each period or auction off a single long-term contract spanning both periods. In both cases, we characterize the optimal incumbent supplier’s investment, the suppliers’ equilibrium bidding strategy and the buyer’s expected cost. Our analysis shows that the supplier always invests more in a long-term contract. However, the buyer’s cost depends on supply base size: it prefers short-term contracts for large supply base size, otherwise it prefers long-term contract. Moreover, we find that system cost is typically lower with short-term contracts and that the suppliers are always better off with short-term contracts. Finally, adding non-discriminatory or discriminatory reserve prices to our model does not fundamentally modify the trade-off, but we find that auctions with discriminatory reserve price are better at balancing this trade-off compared to long or short-term contracts.
Decision on what consumer reactions (support or boycott) to promote is important for nongovernmental organizations and policymakers looking to influence firms’ adoption of corporate social ...responsibility practices. We study how consumer reactions—paying more for certified products or boycotting in the event of responsibility violations—are effective in improving a firm’s uptake of responsibility practices in the sourcing domain. We first build a stylized model to study how consumer reaction affects a firm’s incentives toward responsible sourcing and find that only boycotting reactions by consumers reliably increases a firm’s sourcing from responsible suppliers. We then include behavioral aspects to our stylized model to derive a more nuanced understanding of how consumer reactions affect responsible sourcing. Through behavioral experiments, we first show that a supporting consumer reaction induces a dual-sourcing bias in firms’ sourcing decisions. We then develop a behavioral model of responsible sourcing, incorporating this dual-sourcing bias. Our analysis modifies the normative predictions of the stylized model by showing that a supporting reaction, irrespective of magnitude, always improves responsible sourcing if the boycotting reaction from the market is weak, and that promoting a boycotting reaction always improves responsible sourcing, irrespective of the product type. Our results lead us to a comprehensive and applicable insight for practice: in the supply chains of products with few brand substitutes, creating a supporting reaction in the market is the way to improve firms’ responsible sourcing, and in supply chains of products with many brand substitutes, promoting a boycotting reaction among consumers will lead to more responsible sourcing.
Joint purchasing (JP) agreements are negotiated amongst competing OEMs to enable them to obtain rebates from their supplier(s). The iterative interactions involved in reaching such JP agreements ...result in disclosure of private information that the OEMs might prefer to keep private by procuring individually rather than jointly. This paper investigates how the information sharing dimension affects (1) OEMs’ motivations towards joint purchasing agreements, and (2) consumer surplus, specifically in industries characterized by market demand and technology level uncertainties. Past literature has looked at competitors’ incentives in sharing information, however, there is a fine line between sharing information and collusion/anti-competitive practices. Thus it is important to understand when information sharing, which is inevitable in joint purchasing agreements, will be beneficial to both the OEMs and consumers (and hence likely to be acceptable to regulators). To answer these questions we investigate a multi-period duopoly model with Cournot competition in which OEMs decide on purchasing jointly (or not) in the first stage, and decide on their production quantity in the second stage, under uncertainty and information asymmetry on demand and product technology. We find that a joint purchasing agreement tends to be preferred by OEMs and is also beneficial to consumers when either the substitutability between the two OEMs products is sufficiently low; or when technology level uncertainty is in the intermediate range for a high level of product substitutability; or when the procurement cost saving through JP agreement is high enough. Otherwise, a JP agreement may harm either the OEMs or the consumers. For OEMs bringing periodical updates to the market we provide a framework to analyze how their product level technology uncertainty (i.e., the potential for the product be a “breakthrough”) can affect their strategic decision on purchasing jointly with a competitor.
This paper analyzes optimal auction design when delivery of supply is uncertain. We consider a buyer facing multiple potential suppliers, each having an associated (exogenous) reliability that ...quantifies its risk of supply failure. We design optimal mechanisms that depend on the buyer's level of information regarding the suppliers' cost of production and reliability. When supplier reliability is known, we find that the optimal allocation resembles the allocation under full information, but with inflated production costs. When it is unknown, the same result is true when cost and reliability of a supplier are independent. Furthermore, the buyer does not have to pay any rent for information on suppliers' reliability. Moreover, we assess the benefits of the optimal mechanism compared to traditional auctions that ignore supply risk.
To stay abreast of current supply-market pricing, it is common for procurement managers to frequently organize auctions among a pool of qualified suppliers (the
supply base
). Sole awards can ...alienate losing suppliers and cause them to defect from the supply base. To maintain the supply base and thereby control the high costs of finding and qualifying new suppliers, buyers often employ split awards, which in turn inflate purchase costs. This results in a trade-off that we investigate in an infinite-horizon stationary setting in which the relative cost position of each supplier is randomly drawn in every period. We characterize the optimal split award that minimizes long-run costs (purchasing and qualification) and show that maintaining a constant supply-base size-using a "qualify-up-to" policy-is optimal for the buyer. We find that neither the extent of multisourcing nor the buyer's value of split awards compared with winner-take-all auctions are monotonic in the qualification cost and that split-award auctions can increase ex ante system, buyer, and supplier benefits simultaneously. To our knowledge, this is the first paper studying split-award auctions for supply-base maintenance, and it will hopefully galvanize further research on this important topic.
This paper was accepted by Yossi Aviv, operations management.
Firms mitigate uncertainty in demand and supply by carrying safety stock, planning for excess capacity and diversifying supply sources. In this study, we provide a framework to jointly optimize these ...three levers in a periodic review infinite horizon setting, and in particular we examine how one can reduce inventory and capacity investments through proper diversification strategies. Observing that a modified base‐stock inventory policy is optimal, we find that the capacity‐diversification problem is well behaved and characterize the optimal mix of safety stock, excess capacity and extra number of supply sources. We find that higher supply uncertainty results in higher safety stock, more excess capacity, and higher diversification. But safety stock and diversification are non‐monotonic in demand uncertainty. Our results can be extended to situations in which suppliers are heterogeneous, and can be used to develop effective heuristics.
