SUPPLY CHAIN MANAGEMENT

Supply Chain Management and Asymmetric Information and Adverse Selection

Supply Chain Management and Asymmetric Information and Adverse Selection

Introduction

In many supply chains, a manufacturer often faces the dilemma of sourcing from an established supplier (the big supplier) or a relatively less-known supplier (the small supplier). From a supplier's perspective this means that, when negotiating with the manufacturer, the supplier needs to take into account the manufacturer's other sourcing option. In late 2004, before introducing the new flash memory-based iPods, Apple Computers had the choice of sourcing the flash memory from suppliers such as SigmaTel or Intel1 (see, e.g., Freid 2004). This was a critical decision for Apple because the flash memory chip was an important part of the iPod's cost regardless of the supplier choice. From Intel's perspective, this possible competition from SigmaTel meant that it had to take Apple's contract option with SigmaTel into account when offering a contract to Apple. The dynamics of the possible sourcing contract would be different for each of the two suppliers. A relatively small supplier, such as SigmaTel, perceives the opportunity to work with a well-known manufacturer, such as Apple, as a way to establish reputation.

The manufacturer's business constitutes a large proportion (if not all) of the small supplier's business. These dynamics enable the manufacturer to dictate contract terms. However, a relatively big supplier, such as Intel, can provide expertise and production scale which enables production at a cheaper cost. The big supplier often works with many other customers and the manufacturer's business constitutes a relatively small part of his business. These dynamics enable the big supplier to dictate the contract terms (see, e.g., Holloway 2002 for further discussions). Another example is from the hearing implants industry. In 2004, Cochlear Inc., the world leader in hearing implants, had to decide whether to stay with its current supplier of the electronic assembly, Megaline,2 a company belonging to a large North American electronics corporation, or to start working with a new small supplier, Tinytronics2 (Raz and Stonecash 2004). Although, in this case, the product was not new and the manufacturer (Cochlear) was already working with one of the suppliers, the power dynamics between the manufacturer and the two suppliers would be similar to the Intel/Apple/SigmaTel case.

The information structure regarding production and processing costs plays an important role in sourcing and contracting decisions. For example, in technologically mature environments, such as in the memory chip industry, the production cost for a component is often well known (Billington and Kuper 2003). However, when the technology is new or when a new manufacturer or supplier enters the market (such as in the case of the small supplier), assessing its production cost is often difficult. In addition, even if companies work together for a while, they might not share their costs. For example, in the case of Cochlear and Megaline, the companies do not have an open book policy and thus Megaline does not know Cochlear's processing cost. In this paper, we consider various scenarios regarding the ...