Product Traceability and Warranty Cost Sharing in Supply Chains

Abstract

We consider a supply chain where an OEM (manufacturer) sources a component from multiple suppliers. OEM uses the component to make a product that he then sells to end customers. When a component fails in the field, warranty costs are incurred. The focus of the paper is to examine various mechanisms for sharing the warranty expenses among supply chain members. OEM pays a fixed percentage of total warranty expenses with the rest to suppliers depending on traceability. Without traceability, they are equally shared by suppliers, as originating suppliers of faulty products could not be identified. With traceability, they are traced back to originating suppliers of defective components. Each supplier can exert a costly effort to improve the component's quality, and higher quality means lower warranty cost. Another benefit to a supplier who exerts a quality-improving effort is gaining a larger market share. Suppliers play a multi-person game by independently and simultaneously determining their quality-improving efforts. Using game-theoretic analysis, we characterize equilibrium outcomes of the quality competition game. Equilibrium results are then applied to understand operational impacts of traceability under three different scenarios: 1) the wholesale price and the OEM responsibility are both exogenously fixed, 2) OEM sets the wholesale price, but the OEM responsibility is fixed, and 3) OEM sets both the wholesale price and the OEM responsibility. We also compare the decentralized supply chain with its centralized counterpart and provide conditions for supply chain coordination.