Collaborative Cost Reduction and Component Procurement Under Information Asymmetry

During development of an innovative product there is often considerable uncertainty about component production cost, and it is of interest for both the manufacturer and the supplier to engage in a collaborative effort to reduce this uncertainty and lower the expected cost. Despite the obvious benefits this brings, the supplier may be reluctant to collaborate as he fears revealing his proprietary cost information. We investigate how information asymmetry and procurement contracting strategies interact to influence the supply chain parties' incentives to collaborate. We consider a number of procurement contracting strategies, and identify a simple strategy, expected margin commitment (EMC), that effectively promotes collaboration. The manufacturer prefers EMC if collaboration leads to a large reduction in unit cost and/or demand variability is low. Otherwise, a screening contract based on price and quantity is preferred. We also find that, paradoxically, ex post efforts to enhance supply chain efficiency may hinder ex ante collaboration that precedes production. <i>This paper was accepted by Yossi Aviv, operations management.</i>