ESSAYS ON SUPPLY CHAIN COORDINATION

Author:

Pavlov, Valery

Graduate Program:

Business Administration

Degree:

Doctor of Philosophy

Document Type:

Dissertation

Date of Defense:

March 05, 2009

Committee Members:

Dr Elena Katok, Dissertation Advisor/Co-Advisor
Elena Katok, Committee Chair/Co-Chair
V Daniel R Guide Jr., Committee Member
Anthony Mark Kwasnica, Committee Member
Jenny Xiaoe Li, Committee Member

Keywords:

supply chain
coordination mechanisms
coordinating contracts

Abstract:

A supply chain, which typically employs decentralized decision-making, is coordinated if in the equilibrium firms make decisions that are system-wide optimal. Such decisions, called the first-best, would be made if the supply chain were centralized so that a single decision-maker could force all firms to take recommended actions. Under decentralized decision-making, in order to implement first-best one needs to impose a proper structure of incentives. Supply chain literature, building upon developments in mechanism design, proposes various coordination schemes in the applied business contexts. However, the empirical evidence, coming both from the real world and laboratory experiments, confronts many theoretical predictions. In particular, theoretically optimal contracts are notably more complex than those used in the real world. More importantly, in laboratory experiments the theoretically optimal contracts not just fail to coordinate but, ironically, perform very close to the Double Marginalization benchmark. Thus, legitimate concerns regarding ability of the proposed schemes to coordinate in applied contexts arise. This dissertation focuses on some of the factors leading to coordination failures and investigates their impact on the performance of a supply chain. Chapter "Contingent contract" analyzes a scenario when externalities, created by the third parties, force supply chain partners to use contracts contingent on revealed information. Most of the supply chain literature on coordination deals with perfect information models. The assumption of perfect information is usually justified by instances of information sharing, observed in practice. Researchers conjecture that information sharing ensures perfect information. However, there exists empirical evidence that even under the ultimate form of information sharing, when parties implement "open book accounting", revealed information may not be true. Unfortunately, there is always a possibility to misrepresent information. Notably, under perfect information sharing supply chain partners are likely to find themselves in a situation when they essentially have no choice other than to use a contract that delivers first-best provided that "open books" contain truth. The model of this chapter analyzes performance of a supplier-buyer supply chain under the assumption that questioning each other's reports is prohibitively costly, while parties are aware of possible misrepresentation. Therefore, no matter who offers a contract, it cannot be a screening contract or anything else except a contingent contract that delivers "first-best", given revealed information. The outcome of the arising Bayesian game is distribution-specific, and can be very different from the conjectured performance of a "coordinating" contract. Chapter "Fairness and coordination failures in supply chain contracts" addresses a gap between performance of the contracts suggested by the standard theory, which assumes fully rational profit-maximizing players, and existing data, obtained in the experimental tests of coordinating contracts. Numerous experimental studies find that human decision-makers are neither perfectly rational nor profit-maximizers. While various behavioral factors, such as risk- and loss-aversion, counter-factual payoffs and more general social preferences can greatly affect contracting outcomes, they cannot fully explain the existing data. In the controlled laboratory environment, it is possible to either completely eliminate some of these factors, or, at least, to significantly mitigate and control for them. What is not possible to eliminate, is the players' attitude to contracting outcomes, most commonly called "fairness concerns". The existing models, incorporating fairness concerns into models, assume fairness concerns of players is common knowledge. Realistically, how much a particular person cares about fairness cannot be easily observed or measured and, in fact, is not known to anybody else except that person. In other words, fairness concerns are private information. Therefore, the model presented here takes the next step and treats fairness concerns as private information of players. Given the resulting information asymmetry, it is not surprising that coordination of a dyadic channel with a contract is, in general, no longer possible. At the same time, is possible to coordinate a channel with just a wholesale price contract in case the retailer is sufficiently averse to making higher profit than the supplier. However, we show that when the contract choice is endogenous, the supplier will not choose a wholesale price contract but, instead, a profit-maximizing contract that does not coordinate. The results of the experiment that tests the model's predictions, as well as some underlying assumptions and competing theories, provide strong support for the theory and show that fairness organizes the data very well. Chapter "Competition and contracting in supply chains" presents a simple and, in many respects, robust coordination mechanism. Its performance approaches first-best asymptotically in a setting with one supplier and multiple retailers. By introducing horizontal (Bertrand) competition among the retailers the supplier not only induces retailers to make first-best decisions, but also does it by means of the simplest possible linear pricing scheme. Competition does the entire coordinating job, whereas a wholesale price contract suffices to extract all profit of the competing retailers. Although Bertrand competition is not a new concept, little has been known about its actual performance in the contacting context. It turns out that a competition-based mechanism is not only extremely simple, but it is also robust to several relaxations of the standard assumptions, any of which is enough destroy a coordinating contract. First, it survives certain types of information asymmetry. In the extreme example of private information used in this chapter, the mechanism coordinates the channel even if the supplier is not aware of the very fact of private information. Second, Chapter "Fairness and coordination failures in supply chain contracts" shows how fairness concerns generally make coordination of a dyadic channel impossible. However, for the competition-based mechanism fairness concerns is not an obstacle. Turning to the methodological aspects, we would like to note that the mainstream literature suggests coordinating contracts resulting from models that assume the supplier's ability to make a "take-it-or-leave-it" offer. Credibility of such models has been long debated in the literature. Critics insist that the "take-it-or-leave-it" offer is either not a credible threat in the bilateral monopoly or it is a shortcut, implicitly implying perfect competition on the retailers' side. Allowing for competition explicitly not only avoids this criticism but also brings fuller insights, non-available otherwise.