Should Brands Tighten Certification Standards? Sourcing Under Supplier-Certifier Collusion Risk

Abstract

While enjoying low costs in sourcing from emerging economies, global brands also face serious quality risks in the form of supplier noncompliance with basic environmental and labor standards. Such supplier quality problems are usually latent at the contracting stage, but could cause the brands significant financial and reputational damages at a later time, creating a classic/lemons problem. A common approach to mitigating this problem is to screen the suppliers via third-party quality certifications. However, in regions with lax law enforcement, a substandard supplier may very well bribe the certifier to pass the certification. Given the possibility of such supplier-certifier collusion, should the buyer tighten or loosen the certification standard? In this paper, we develop an analytical model to answer this intriguing question. Specifically, we assume the buyer offers the supplier a take-it-or-leave-it contract consisting of a uniform payment and a minimum quality standard. The collusion, modeled as a side contract between a substandard supplier and an unethical certifier, takes place after the buyer makes the first move. We show that the equilibrium certification standard can be either higher or lower than the standard in a collusion-free setting. The result is driven by three key factors: the probability of the certifier being ethical/unethical, the certifier's penalty cost upon the collusion being discovered, and the buyer's externality cost due to the collusion. We also find that, to prevent collusion, punishing the colluding certifier alone may backfire sometime, but holding the buyer accountable for the collusion scandal is always effective (even though the buyer does not directly involve in the supplier-certifier collusion). Finally, we extend the model by considering the effects of mandatory standard and price premium. Our analysis suggests that all else being equal, a high mandatory standard or a high price premium may induce more collusion in equilibrium.