How Cooperative Is ‘Cooperative Investment'?: Supply Chain Contracting in Presence of Epistemic Quality Uncertainty

Introduction

The concept of buyer-supplier cooperation developed in Japan after the First World War when the extreme demand for goods insisted companies to utilize their suppliers in order to increase their productions temporarily. (Nishiguchi, 1994). Till the 1960s and 1970s, buyer-supplier relationships were considered as adversarial arm’s-length transactions, characterized primarily by bargaining on price. From the beginning of the 90s, relationships demanded an even greater degree of interaction due to the added need for product innovation and cooperation in technological developments, and this high level of interaction is termed as a partnership (Lamming, 1993). Organizations moved towards a greater cooperative relationship with their suppliers (Spekman, 1988) because the buyer-supplier relationship plays an extremely important role in firm’s ability to respond to irregular changes in the industry in which the firm operates (Musanga et al., 2015).

Cooperation in a supply chain is characterized by a set of joint actions of firms in close relationship to accomplish a shared goal that is mutually beneficial (Mentzer et al., 2000; Moharana et al., 2012). Apart from dealing with material and information flows, Supply Chain Management (SCM) deals with the management of financial flows in a network consisting of vendors, manufacturers, distributors, and customers (Anupindi and Bassok 1999). Managing the financial flows in a relationship can be ensured by a contract between the buyer and the supplier. This process can be termed as supply chain contracting (Höhn, 2010). According to Höhn (2010), an important objective of supply chain contracting (SCC) is a system-wide performance improvement. A second motive is sharing the risk arising from the uncertainty in the supply chain. Another motive of SCC is facilitating long-term relationships (Tsay et al., 1999). Supply chain performance may be suboptimal due to lack of coordination. To facilitate coordination, the supply chain resorts to contracts. In general, the goal is to write contracts that induce coordination through appropriate provisions for information and incentives such that supply chain performance will be optimized. This type of approach recurs in a broad range of settings. Cachon (2003) and Chen (2003) review the research on supply chain contracts. Early overviews on supply chain coordination with contracts were given by Whang (1995), Cachon (1999), Lariviere (1999), and Tsay et al. (1999).