Using a Dual-Sourcing Option in the Presence of Asymmetric Information About Supplier Reliability: Competition vs. Diversification

Authors:
Zhibin (Ben) Yang;Göker Aydın;Volodymyr Babich;Damian R. Beil
Affiliations:
Lundquist College of Business, University of Oregon, Eugene, Oregon 97403;Kelley School of Business, Indiana University--Bloomington, Bloomington, Indiana 47405;McDonough School of Business, Georgetown University, Washington DC 20057;Stephen M. Ross School of Business, University of Michigan, Ann Arbor, Michigan 48109
Venue:
Manufacturing & Service Operations Management
Year:
2012

Citing 18
Cited 1

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Abstract

We study a buyer's strategic use of a dual-sourcing option when facing suppliers possessing private information about their disruption likelihood. We solve for the buyer's optimal procurement contract. We show that the optimal contract can be interpreted as the buyer choosing between diversification and competition benefits. Better information increases diversification benefits and decreases competition benefits. Therefore, with better information the buyer is more inclined to diversify. Moreover, better information may increase or decrease the value of the dual-sourcing option, depending on the buyer's unit revenue: for large revenue, the buyer uses the dual sourcing option for diversification, the benefits of which increase with information; for small revenue, the buyer uses the dual sourcing option for competition, the benefits of which decrease with information. Surprisingly, as the reliability of the entire supply base decreases, the buyer may stop diversifying under asymmetric information (to leverage competition), whereas it would never do so under symmetric information. Finally, we analyze the effect of codependence between supply disruptions. We find that lower codependence leads the buyer to rely less on competition. Because competition keeps the information costs in check, a reduction in supplier codependence increases the buyer's value of information. Therefore, strategic actions to reduce codependence between supplier disruptions should not be seen as a substitute for learning about suppliers' reliabilities.