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

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

Arijit Mitra (Xavier Institute of Management, Bhubaneswar (XIMB), Bhubaneswar, India), Sumit Sarkar (XLRI Jamshedpur, Jamshedpur, India) and T.A.S. Vijayaraghavan (XLRI Jamshedpur, Jamshedpur, India)
Copyright: © 2019 |Pages: 19
DOI: 10.4018/IJSDS.2019010104

Abstract

The literature identifies the importance of cooperation in enhancing supply chain performance, but only a few papers have studied the role of cooperative investment in supply chain contracting. This article contributes to the literature of supply chain contracts by highlighting the importance of a cooperative investment in improving quality in presence of uncertainty. When the delivery of a high-quality product is uncertain and costly, the supplier may choose to deliver a less costly standard product, delivery of which is not uncertain, and hence the buyer needs to incentivize the supplier to take the risk. Using a principal-agent set-up, this article shows that incentivizing the supplier to choose the risky action of attempting delivery of the high-quality product is easier for the buyer in presence of shared cooperative investment that reduces epistemic quality uncertainty. However, the supplier passes the entire burden of investment on the buyer. The optimal investment for the buyer depends on parameters that determine effectiveness of the investment in reducing quality uncertainty.
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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).

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