Buyer Invests Research Articles

The value of investment in nonexclusive contracts

AbstractWe consider the strategic incentives to invest in an environment where suppliers compete with nonexclusive contracts. When trade is nonexclusive, that is, the buyer relates with many suppliers simultaneously, the buyer's investment affects her outside option when excluding a supplier. The buyer's investment allows for cheaper substitution of the trade loss arising from the excluded supplier. In equilibrium, even though each supplier fully appropriates the investment return it receives in isolation, the buyer wants to invest to gain leverage over competing suppliers. Our model uncovers an essential role of nonexclusive contracts because they promote the buyer to invest.

Supplier development under cooperative and non-cooperative investment structures

PurposeThis study analyzes supplier development investment decisions under a triadic setting (two buyers and a common supplier). In a triadic setting, the supplier development investment decision of one buyer can have a spillover effect of the benefits on other buyer. Therefore, it is utmost important for the investing buyer to understand the impact of benefit spillover on other competing buyers'. Therefore, one of the purposes of this study to analyze the supplier development investment decision of buyers under two scenarios. First, under cooperative development structure where both buyers jointly invest in supplier and share equal benefits. Second, non-cooperative investment structure where both buyers individually invest in supplier development and share unequal benefits.Design/methodology/approachIn order to assess the impact of supplier development investment decisions on the profitability of buyers and the common supplier, the authors used game-theoretic approach. The authors design a Stackelberg leader-follower game where the supplier acts as Stackelberg leader and buyers follow the supplier's pricing decision to maximize their profit level. Additionally, both buyers decide either to cooperate or non-cooperate while investing in supplier development.FindingsThe results show that the cooperative investment is always an optimal strategy for buyers and supplier. Interestingly, the efficient buyer's share of investment level is lower under non-cooperative investment structure and he is better-off due to its capability of taking advantage from the other buyer's investment. However, the inefficient buyer, on the other hand, is worse-off under non-cooperative investment. Furthermore, comparative analysis between the two shows that initially, the buyer who extracts more profit because of the other buyers' development investment tends to prefer the non-cooperative development investment set up. However, after a certain point, the same buyer is better-off under cooperative development investment through cooperation, and sharing equal benefit of the supplier's development, as the supplier in turn, starts charging a higher wholesale price under non-cooperative investment case.Originality/valueTo the best of authors’ knowledge, extant literature on supplier development has mostly focused on. One supplier-one buyer; thus, the learning spillover effect has almost been unexplored. In real-life, different buyers often purchase from the shared supplier. Therefore, it is important to analyze the spillover of supplier development benefits due to investment of one buyer on other buyer and deriving the condition under which buyers would be incentivized to invest jointly or individually.

The varying impact of buyer and supplier expected relationship-specific investments on relationship governance

PurposeThe purpose of this paper is to investigate the differential influence of buyer and supplier relationship-specific investments (RSI) on a buyer’s relationship governance decisions.Design/methodology/approachBased on transaction economics and social exchange theories (SET), the authors develop a framework to understand how and when buyer and supplier RSI influence governance decisions. This model was tested using a survey of 301 Information Technology (IT) procurement professionals across a multitude of industries.FindingsThis research shows that buyer and supplier RSI impact governance decisions differently. Supplier investments are positively associated with relationship formalization when goals between both parties are shared. Buyer investments are more strongly related to formalization in technologically uncertain environments.Originality/valueThis research adds to the literature by integrating arguments from both transaction cost and SET to hypothesize why buyer and supplier investments have a differential impact on relationship governance decisions. In line with these arguments, it ultimately demonstrates conditions that render such investments more/less influential.

The effect of human errors on an integrated stochastic supply chain model with setup cost reduction and backorder price discount

This study develops an integrated vendor–buyer inventory model for a supply chain where quality issues and human error affect its coordination. Each lot shipped to the buyer contains defective items, with a rate which randomly changes from a lot to the other. The buyer inspects every shipped lot to segregate defective items. However, the inspection process at the buyer’s end goes wrong in the classification of defective and non-defective items. On the other hand, the buyer may run out of inventory, but in order to avoid lost sales, he/she offers a price discount on the backlogged items to his/her customers. Due to the vendor-buyer relationship, the buyer invests in reducing the setup cost of the vendor. Supply chain’s lead-time is considered variable, and two models are developed based on the probability distribution of the lead-time demand. In the first model, it is assumed that lead-time demand follows a normal distribution, while in the latter one, it does not follow any certain distribution. Two models are developed to determine the joint optimal decision variables that minimize the total cost of the supply chain. Two iterative algorithms are developed to obtain the optimal solution for both models. A set of numerical analysis and sensitivity analysis are conducted to gain insights.

Inclusiveness of contract farming along the vertical coordination continuum: Evidence from the Vietnamese rice sector

The Vietnamese government is currently attempting to upgrade rice value chains in the Mekong River Delta by encouraging (i) vertical coordination between exporters and farmers through contract farming, and (ii) horizontal coordination among farmers through the “small farmers, large field” program. Previous studies on the determinants of contract farming participation assume that firms offer only a single contract type, whereas in reality, farmers may face a continuum of exclusive contract options. Devising correct and targeted policies for fostering contract inclusiveness hence crucially hinges on deploying correct econometric specification of the decision to participate in contract farming. We model contract farming participation and intensity in four different ways along the vertical coordination continuum: as a discrete, categorical, ordered, and continuous choice. We find that older, smaller and horizontally coordinated farmers with higher levels of trust in buyers tend to secure higher levels of buyer investment through increased vertical coordination. In contrast with the common finding in the literature that contract participation is biased towards larger farms, our findings from Vietnam suggest that the scale bias of contract farming could be successfully relaxed through horizontal coordination and even reversed under increasing levels of vertical coordination as smaller farmers are found to secure higher levels of buyer investment. These findings highlight the role both policies can play in fostering inclusiveness of contract farming in rice value chain upgrading in Vietnam.

Learning-by-doing may not be enough to sustain competitiveness in a market

• Buyer invests in the vendor's process to improve its competitive market position. • Develops an EOQ model with price dependent demand, analogous to head flow. • A faster learning rate than competitors ensures a prolonged profitability . • Improvements beyond learning-by-doing could be required for firms survivability . The economic order quantity model and its variants are the oldest reported scientific inventory models in the literature. They are mathematically simple to use and understand. This characteristic contributed to their popularity. However, they have limitations that restrict their application in practice. Researchers have extended those models by relaxing some of their restrictive assumptions. One of the main limitations of the EOQ model is the estimation of its cost parameters, such as setup and holding costs, which include some hidden (or difficult to estimate) components. Emerging research proposes using the second law of thermodynamics when to measure the hidden (entropy) costs of inventory systems. Another research stream focuses on learning-by-doing, which reduces the unit cost of a product, thus reducing its price and enhancing a firm's competitiveness. This paper assumes that a buyer receives a shipment from its vendor following the EOQ model. The buyer invests in the vendor's process to accelerate learning (mainly workers training, among other things). The buyer's unit purchase cost reduces because of learning at the vendor's side. The buyer's competitors also learn, increasing competitiveness. For this purpose, we develop an EOQ model where price-dependent demand is analogous to a heat transfer equation, which is used to determine the entropy cost. It accounts for improvement by learning as a result of the buyer's investment to compete in a market. The implementation and management of improvement programs are not usually smooth, resulting in disorder quantified by an entropy cost function. The developed EOQ model is investigated with and without entropy costs. Numerical results representing different scenarios are provided to illustrate the behavior of the models and identify the factors affecting the decision variables and, subsequently, the buyer's profitability. The results showed that in a competitive market, the buyer has to maintain a learning rate faster than those of its competitors to ensure a prolonged, but indefinite, profitability. The results also showed that investment in learning is meaningful when the competition is fierce.

Stochastic supply chain model with imperfect production and controllable defective rate

This paper investigates the impact of ordering cost reduction and process quality improvement on an integrated vendor–buyer inventory system with variable lead time in just-in-time (JIT) manufacturing environment. We assume that the vendor invests money in order to improve the production process quality and reduce the number of defectives, and buyer invests money to reduce the ordering cost. Each lot received by the buyer contains a certain percentage of defective items and it is assumed that there is an inspection activity on the part of the buyer with a fixed screening rate greater than the demand rate. Shortages are partially backlogged with a certain limit of backorder price discount. The objective of this study is to obtain the optimal decisions and the best investment policy to minimise the joint total cost incurred by the buyer and the vendor. An efficient algorithm is developed to determine the optimal policy. The model is illustrated through a numerical example. From the numerical results, it is observed that significant savings can be achieved through the reductions of lead time, ordering cost and defective rate. Some managerial insights also obtained from the numerical study.

Supplier Quality Management: Investment, Inspection, and Incentives

Buyers can manage product quality sourced from suppliers in three ways: they can improve the quality incoming from suppliers directly by investing in suppliers to improve a process/product, they can improve the incoming quality indirectly by incentivizing supplier quality‐improvement efforts, and/or they can control the quality outgoing to subsequent processes by inspecting incoming units. In this study, we study a buyer's use of these three instruments—investment, incentives, and inspection—to manage the sourced quality. To do so, we consider a general relationship between the buyer's direct investment effort and supplier's quality‐improvement effort, allowing them to be complementary, substitutable, or additive in their quality‐improvement effects. For situations in which the buyer and the supplier decide their efforts simultaneously with contractible internal‐failure events, we identify three types of strategies: the investment‐based strategy (focusing on the buyer's investment effort) for strongly substitutable efforts, the inspection‐based strategy (focusing on inspection) for strongly complementary efforts, and the integrative strategy (emphasizing all three instruments) for additive efforts. If buyer‐investment commitment is possible, then the inspection‐based strategy in which both parties defect in their efforts will be replaced by a collaboration‐based strategy in which both parties exert high efforts to improve quality. Contracting upon external failures (in addition to internal failures) does not change this strategy pattern; however, when combined with buyer‐effort commitment, such a contract achieves the first‐best result.

Governing Supply Relationships: Evidence from the Automotive Industry

A large empirical literature analyzes determinants of the make-or-buy decision. Transaction cost economics highlights the role of asset specificity, the property rights theory focuses on the relative marginal contributions to joint surplus creation, and some evidence suggests that making transactions more contractible facilitates outsourcing. We use a unique transaction-level dataset of outsourced automotive components to predict carmakers’ choices between four distinct ways of organizing sourcing relationships. We derive conditional predictions for three characteristics: (i) the complexity or contractibility of a transaction, (ii) how objectively codifiable performance is, and (iii) the supplier’s capabilities. For example, while dominant buyer investments might predict vertical integration, as in the property rights theory, other characteristics might convince a buyer to simply re-organize the collaboration with the supplier in a more suitable way. Our results suggest that “buy” relationships differ systematically and that the predictive power of our variables extend from the make-or-buy decision to how-to-buy.

A new warranty policy based on a buyer’s preventive maintenance investment

For large equipment, we present a new warranty policy wherein the buyer invests in the preventive maintenance (PM) cost within the product’s life cycle to reduce the losses from production downtime. We construct discounted cost decision models for both buyers and sellers based on different PM strategies within the product’s life cycle. The win-win intervals were obtained under the condition that the buyer intends to invest in the PM costs and the seller intends to take PM actions. We also theoretically and numerically evaluate the effects of failure rates, various fees, discount factors, and PM strategies on the buyer’s maximum PM investment and the seller’s minimum acceptable PM investment under different PM strategies. The main results indicate that (1) if the win-win between the buyer and the seller was realized, then the seller must increase the PM efforts; and (2) the warranty policy presented herein is suitable for products with high failure rates, high maintenance costs, significant losses from downtime, and low PM costs.

A vendor-buyer supply chain model for time-dependent deteriorating item with preservation technology investment

This paper considers a two-echelon supply chain model with a single-vendor and a single-buyer who sells a single product which is deteriorating in nature. The deterioration rate increases with time and it also depends on the product's expiration date. The buyer invests capital to preserve the item and reduce deterioration cost. The demand at the buyer's end depends on the selling price. The vendor's production process is not perfectly reliable; it may shift from an in-control state to an out-of-control state at any random time during a production run and produce some defective (non-conforming) items. The vendor follows a lot-for-lot policy for replenishment made to the buyer. The average profit of the supply chain is derived and an algorithm for finding the optimal solution is developed. A numerical example is provided to validate the proposed model and examine the effectiveness of preservation technology investment. Sensitivity analysis is carried out to investigate the impacts of key model-parameters on optimal decisions.

Caveat Venditor: The Conditional Effect of Relationship-Specific Investment on Contractual Behavior

We offer a new perspective on the effect of relationship-specific investment on contract complexity, which has broad implications because complex contracts and vertical integration are substitutes. A simple model using transaction cost economics (TCE) predicts that buyer and seller relationship-specific investments have opposite effects on contract complexity. The model also predicts the signs of biases in OLS estimates of the effect of relationship-specific investments: unobserved heterogeneity causes downward bias in the estimated difference between the effects of buyer and seller specific investment, reducing the probability of finding opposite effects. We examine these predictions using data on agreements made by Romanian firms. When accounting for unobserved heterogeneity, seller relationship-specific investment has a positive effect on contract complexity while buyer investment has a negative effect. OLS estimates do not generate this result. The unique contribution of the paper is in simultaneously implementing TCE empirically, countering the problem of unobserved heterogeneity, generating estimates of the effects of specific investment that have opposite signs on opposite sides of the agreement, and explaining patterns of bias in the OLS estimates. Additionally, regional variation in court quality affects the complexity of contracts, suggesting that even moderate amounts of legal reform can have appreciable effects.

Caveat Venditor: The Conditional Effect of Relationship-Specific Investment on Contractual Behavior

We examine the effect of relationship-specific investment on contract complexity, which has broad implications because complex contracts and vertical integration have similar causal origins. It is usually assumed that transaction cost economics (TCE) implies that relationship-specific investment always has a positive effect on complexity. Using a simple TCE model and the assumption that firms are credit and cash-flow constrained, we predict that the effect can be of opposite sign on opposite sides of a relationship. We also derive hypotheses on omitted-variable bias in OLS estimates of the effect of relationship-specific investments, showing that such biases reduce the probability of finding opposite signs. Our main results are on the empirical side, where we examine these predictions using detailed survey data on a broad sample of agreements made by Romanian firms. Seller relationship-specific investment has a positive effect on contract complexity while buyer investment has a negative effect. This result is obtained from a variety of estimating procedures that address omitted-variable bias in different ways, but not from OLS. The result disappears in the small sample of agreements that involve buyer prepayment, suggesting that the interaction of seller vulnerability and credit constraints drives the results. Hence, financial and legal development are substitutes in solving transactional problems. The broader context of the paper is therefore institutional development. The paper shows that firms invest more in law when courts are of better quality.

An integrated production-inventory model with preservation technology investment for time-varying deteriorating item under time and price sensitive demand

This paper deals with a supply chain comprising of single vendor and single buyer who sells single product which is deteriorating in nature. The deterioration is time dependent. The buyer invests funds on preservation technology to preserve the item and reduce deterioration rate in the inventory. The classical optimisation is used to optimise the total profit of the supply chain with respect to selling price, cycle time and investment for preservation technology. The manufacturer production process is not perfectly trustworthy; it may shift from an in control state to an out of control state at any random time during a production run and made some imperfect items. The vendor follows lot for lot policy for refill produced to the buyer. The model is supported with numerical examples and also established a scenario of the model. Sensitivity analysis is done to deduce managerial insights.

Strategic Capacity Investment under Hold-up Threats: The Role of Contract Length and Width

We analyze the impact of the length of incomplete contracts on investment and surplus sharing. In the bilateral relationship explored, the seller controls the input and the buyer invests. With two-part tariffs, the length of the contract is irrelevant: the surplus is maximal and goes to the seller. In linear contracts, the seller prefers the shortest contract and the buyer the longest one. Further, the commitment period concentrates the incentives, whereas afterwards there is rent extraction. The socially efficient contract is as short as possible; yet, long contracts can be promoted because of the surplus they allocate to the buyer.

Identity changes and the efficiency of reputation systems

Reputation systems aim to induce honest behavior in online trade by providing information about past conduct of users. Online reputation, however, is not directly connected to a person, but only to the virtual identity of that person. Users can therefore shed a negative reputation by creating a new account. We study the effects of such identity changes on the efficiency of reputation systems. We compare two markets in which we exogenously vary whether sellers can erase their rating profile and start over as new sellers. Buyer trust and seller trustworthiness decrease significantly when sellers can erase their ratings. With identity changes, trust is particularly low towards new sellers since buyers cannot discriminate between truly new sellers and opportunistic sellers who changed their identity. Nevertheless, we observe positive returns on buyer investment under the reputation system with identity changes, and our evidence suggests that trustworthiness is higher than in the complete absence of a reputation system.

Expectation Damages and Bilateral Cooperative Investments

We examine the efficiency of the standard breach remedy expectation damages in a setting where the buyer invests cooperatively and the seller invests both cooperatively and selfishly. Contracts may specify a required quality level and an upper bound to the seller's coordination costs. We find that it is optimal to write an augmented Cadillac contract in which quality is stipulated such that it cannot be met with positive probability together with a very low price. Thus, the seller becomes a residual claimant and the coordination-cost threshold can be used to balance the incentives of the buyer.

"When Can You Trust “Trust”?Calculative Trust, Relational Trust, and Supplier Performance"

Despite the many studies showing the positive association of trust and buyer-supplier exchange outcomes, extant research has not empirically assessed two distinct bases for trust: calculative trust, in which incentives align goals, and relational trust, in which a shared identity aligns goals. Our findings from 211 buyer–supplier relationships demonstrate that both relational trust and calculative trust simultaneously and positively influence supplier performance, yet calculative trust has a stronger relationship with performance than relational trust does. Our empirical results further show important differences exist in when to trust “trust”. When the buyer invests in supplier-specific assets, only relational trust is associated with higher supplier performance. Yet, when behavioral uncertainty is high, calculative trust is associated with higher levels of supplier performance, but relational trust is not. Finally, when market uncertainty exists, both relational trust and calculative trust are positively associated with supplier performance.

The Role of Revenue‐Focused Managerial Performance Measures in Supply Chain Coordination

Many firms employ revenue‐focused managerial performance measures (RF‐MPMs) that cause managers to worry more about revenues than about costs. Although this can seemingly misalign the interests of a manager, we show that the use of such measures can help supply chain partners to overcome hold‐up issues with respect to capacity and promotion investments. We develop a game theoretic model in which two supply chain partners engage in repeated interactions in which the supplier invests in capacity and the buyer invests in demand promotion. Following the realization of demand in each period, the two firms negotiate over the output quantity and wholesale price. The novelty of our model is that we allow the owners of each firm to delegate decision‐making power and negotiating responsibility to a free‐agent manager. We characterize the conditions under which the owners of both firms employ RF‐MPMs in equilibrium and benefit from doing so. For a special case of our model, we show that for the owners of the buyer, an RF‐MPM is equivalent to a price only relational contract, and that it complements a price and quantity relational contract as a mechanism for mitigating hold‐up issues.

Sourcing for Quality: Incentives, Cooperation, and Inspection

Buyers can manage product quality sourced from suppliers in three ways: they can improve the quality incoming from suppliers directly by investing in suppliers to improve a process/product, they can improve the incoming quality indirectly by incentivizing supplier quality-improvement efforts, and/or they can control the quality outgoing to subsequent processes by inspecting incoming units. In this paper, we study a buyer's use of these three instruments -- investment, incentives, and inspection -- to manage the sourced quality. To do so, we consider a general relationship between the buyer's direct investment effort and supplier's quality-improvement effort, allowing them to be complementary, substitutable, or additive in their quality-improvement effects. For situations in which the buyer and the supplier decide their efforts simultaneously with contractible internal-failure events, we identify three types of strategies: the investment-based strategy (focusing on buyer's investment effort) for strongly substitutable efforts, the inspection-based strategy (focusing on inspection) for strongly complementary efforts, and the integrative strategy (emphasizing all three instruments) for additive efforts. If buyer-investment commitment is possible, then the inspection-based strategy in which both parties defect in their efforts will be replaced by a collaboration-based strategy in which both parties exert high efforts to improve quality. Contracting upon external failures (in addition to internal failures) does not change this strategy pattern; however, when combined with buyer-effort commitment, such a contract achieves the first-best result.