We study the alliance formation strategy among suppliers in a one downstream firm-n upstream suppliers framework. Each supplier faces an exogenous random shock that may result in order default. Each of them also has access to a recourse fund that can mitigate this risk. The suppliers can share the fund resources within an alliance, but need to allocate profits of the alliance among the partners. In this context, suppliers need to decide whether to join larger alliances that have better chances of order fulfillment or smaller ones that may grant them higher profit allocations. We first analytically characterize the exact coalition-proof Nash-stable coalition structures that would arise for symmetric complementary or substitutable suppliers. Our analysis reveals that it is the appeal of default risk mitigation, rather than competition-reduction, that motivates cooperation. In general, a more risky and/or less fragmented supply base favors larger alliances, whereas substitutable suppliers and customer demands with lower pass-through rates result in smaller ones. We then characterize the stable coalition structures for an asymmetric supplier base. We establish that grand coalition is more stable when the supplier base is more homogenous in terms of their risk levels, rather than divided among few highly risky suppliers and other low-risk ones. Going one step further, our investigation of endogenous recourse fund levels for the suppliers demonstrates how financing costs affect suppliers investment in risk-reducing resources, and consequently their coalition formation strategy. Lastly, we discuss model generalizations and show that, in general, our insights are quite robust.
Published November 2014 , 49 pages