Group for Research in Decision Analysis

Supply Side Story: Risks, Guarantees, Competition and Information Asymmetry

Mehmet Gumus Professor, Desautels Faculty of Management, McGill University, Canada

The risk of supply disruption has increased as firms have started procuring more from cheaper, but unreliable, suppliers. In this paper, we model a supply chain comprising a single buyer and two suppliers who compete for the buyer's order. One of the suppliers is more expensive but reliable, while the other (unreliable) one is cheaper but faces risk of supply disruption. The risk level of the unreliable supplier might be private information for her and this lack of visibility further contributes to the buyer's purchasing risk. In such settings, the unreliable supplier often offers a price and quantity (availability) guarantee to the buyer as part of her contract terms. Our objective is to understand the underlying motivation for such a guarantee offer and the effects such an offer have on the performance of the chain partners. We characterize the equilibrium contracts for the two suppliers, and the buyer's procurement strategy for both symmetric and asymmetric information cases. Our analysis indicates that supply guarantee plays two important roles. First, it allows the unreliable supplier to better compete against the reliable one by providing supply assurance to the buyer. More importantly, when information asymmetry risk is high, a guarantee offer enables the unreliable supplier to credibly signal her true supply risk to the buyer improving the visibility in the chain. This additional role causes guarantees to be a more usable strategy in an asymmetric information setting (compared to a symmetric one) from the viewpoint of the unreliable supplier. However, from the buyer's perspective, guarantee provision in an asymmetric setting might reduce the competition between the suppliers resulting in higher contract prices, and, consequently, higher costs for him (and higher profits for the reliable supplier).