Value of Information in Contract Manufacturing
Mohammad E. Nikoofal
PhD student in Operations Management, McGill University
Date: November 15, 2013
Time: 12:00 pm - 02:00 pm
Location: Room 310
Although the contract manufacturing emerges as a dominant business model in many industries and allows its users to focus on their core competencies, the recent surveys show that it comes at the cost of increased risk, reduced visibility, and loss of control. In this presentation, we discuss two techniques that provide different sides of the supply chain with the critical information regarding the extent of supply risk. Namely, in the first one, it is the upstream party (supplier) who makes a costly diagnostic investment in the form of test production, whereas in the second one, it is the downstream party (manufacturer) who incurs the diagnostic cost in the form of audit. By comparing the agency costs associated with the optimal menu of contracts with and without these diagnostic techniques, we completely characterize the value of test production and audit for all the cases from the perspectives of manufacturer, and supplier as well as total supply chain. First of all, even though test production (resp., audit) increases (resp., decreases) the degree of information asymmetry between the supply chain parties, contrary to intuition and (in some cases) literature, we characterize the conditions under which diagnostic technique can be a win-win strategy, i.e., both the manufacturer and supplier can benefit from test production and audit. Second, the manufacturer is always better off when she incurs diagnostic cost in the form of audit; however, she may worse off when the supplier invests in test production. Finally, we show that the information acquired through test production and audit enables the manufacturer to customize the contract offerings based on the true type of supply risk (faced by the supplier).